** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

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** **

**FORM 10-Q**

** **

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** **

**x****                             ****QUARTERLY REPORT UNDERSECTION 13 OR 15(d) OF THESECURITIESEXCHANGE ACT OF 1934**

** **

**For the quarterly period ended March 31, 2008**

** **

**o****                                ****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

** **

**Forthe transition periodfrom                   to                   **

** **

**Commissionfile number 1-14762**

 

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**THE SERVICEMASTER COMPANY**

(Exact name of registrantas specified in its charter)

** **

| **Delaware**                                                                                | ** ** | **36-3858106**                                   |
|---------------------------------------------------------------------------------------------|------------|--------------------------------------------------|
| (State or other jurisdiction ofincorporation or organization) |       | (IRS Employer Identification No.) |

** **

| **860  Ridge Lake Boulevard, Memphis, Tennessee****· 38120**      |
|------------------------------------------------------------------------|
| (Address of  principal executive offices)    (Zip Code) |

 

**901-597-1400**

(Registrant’s telephonenumber, including area code)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes o  No x

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,a non-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer  o                     |   | Accelerated filer o          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer x                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes  o  No x

 

On July 24,2007, the registrant completed a transaction pursuant to an Agreement and Planof Merger, dated as of March 18, 2007, among the registrant and twocorporations formed to effect the merger transactions. As a result of themerger transaction, the registrant became a privately held corporation and itsequity shares are no longer publicly traded. At April 28, 2008, 1,000shares of the registrant’s common stock were outstanding, all of which wereowned by CDRSVM Holding, Inc.

 

The ServiceMasterCompany is not required to file this Quarterly Report on Form 10-Q withthe Securities and Exchange Commission, and is doing so on a voluntary basis.

 

 

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**TABLE OF CONTENTS**

 
| ** **                                                                                                                                          | **Page  No.** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|---------------|
| THE SERVICEMASTER COMPANY (Registrant) -                                                                                                            |          |
|                                                                                                                                                |          |
| Part I. Financial Information                                                                                                                  |          |
|                                                                                                                                                |          |
| Item 1: Financial Statements  (Unaudited)                                                                                                           |          |
|                                                                                                                                                |          |
| Condensed  Consolidated Statements of Operations for the three months ended  March 31, 2008 (Successor) and March 31, 2007 (Predecessor). | 3             |
|                                                                                                                                                |          |
| Condensed  Consolidated Statements of Financial Position as of March 31, 2008 and  December 31, 2007                                      | 4             |
|                                                                                                                                                |          |
| Condensed Consolidated  Statements of Cash Flows for the three months ended March 31, 2008 (Successor)  and March 31, 2007 (Predecessor). | 5             |
|                                                                                                                                                |          |
| Notes to  Condensed Consolidated Financial Statements                                                                                               | 6             |
|                                                                                                                                                |          |
| Item 2:  Management’s Discussion and Analysis of Financial Condition and Results of Operations                                                 | 19            |
|                                                                                                                                                |          |
| Item  3: Quantitative and Qualitative Disclosures About Market Risk                                                                            | 34            |
|                                                                                                                                                |          |
| Item 4T:  Controls and Procedures                                                                                                                   | 35            |
|                                                                                                                                                |          |
| Part II. Other  Information                                                                                                                    |          |
|                                                                                                                                                |          |
| Item  1A: Risk Factors                                                                                                                              | 36            |
|                                                                                                                                                |          |
| Item  6: Exhibits                                                                                                                                   | 36            |
|                                                                                                                                                |          |
| Signature                                                                                                                                           | 37            |

 

2

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### **PART I.FINANCIAL INFORMATION**

**ITEM 1. FINANCIAL STATEMENTS**

### **THE SERVICEMASTER COMPANY**

### **CondensedConsolidated Statements of Operations (Unaudited)**

*(In thousands)*

* *
| ** **                                                                                 | ** ** | **Successor**                | ** ** | ** ** | **Predecessor**              | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------|------------------------------|------------|
| ** **                                                                                 | ** ** | **Three**                    | ** ** | ** ** | **Three**                    | ** ** |
| ** **                                                                                 | ** ** | **months ended**        | ** ** | ** ** | **months ended**        | ** ** |
| ** **                                                                                 | ** ** | **March 31, 2008** | ** ** | ** ** | **March 31, 2007** | ** ** |
| **Operating Revenue**                                                                 |       | $                            | 632,231    |       |                         | $          | 673,495 |   |
|                                                                                       |       |                         |       |       |                         |       |
| **Operating Costs and Expenses:**                                           |       |                         |       |       |                         |       |
| Cost of services rendered and products sold                  |       | 417,368                      |       |       | 443,350                      |       |
| Selling and administrative expenses                                         |       | 171,116                      |       |       | 193,219                      |       |
| Amortization expense                                                                       |       | 50,674                       |       |       | 2,266                        |       |
| Merger related charges                                                                     |       | 50                           |       |       | 2,540                        |       |
| Restructuring charges                                                                      |       | 3,325                        |       |       | 7,058                        |       |
| Total operating costs and expenses                                     |       | 642,533                      |       |       | 648,433                      |       |
|                                                                                       |       |                         |       |       |                         |       |
| **Operating (Loss) Income**                                                           |       | (10,302                      | )          |       | 25,062                       |       |
|                                                                                       |       |                         |       |       |                         |       |
| **Non-operating Expense (Income):**                                              |       |                         |       |       |                         |       |
| Interest expense                                                                      |       | 89,586                       |       |       | 14,264                       |       |
| Interest and net investment loss (income)                                   |       | 6,045                        |       |       | (8,066                       | )          |
| Minority interest and other expense, net                          |       | 132                          |       |       | 2,049                        |       |
|                                                                                       |       |                         |       |       |                         |       |
| **(Loss) Income from Continuing Operations  before Income Taxes** |       | (106,065                     | )          |       | 16,815                       |       |
| (Benefit) provision for income taxes                                             |       | (30,971                      | )          |       | 6,767                        |       |
|                                                                                       |       |                         |       |       |                         |       |
| **(Loss) Income from Continuing Operations**                                     |       | (75,094                      | )          |       | 10,048                       |       |
|                                                                                       |       |                         |       |       |                         |       |
| Loss from businesses held pending sale and discontinued operations, net  of income taxes   |       | (748                         | )          |       | (1,499                       | )          |
| **Net (Loss) Income**                                                                 |       | $                            | (75,842    | )          |                         | $          | 8,549 |   |

 

*See accompanying Notes to the Condensed Consolidated FinancialStatements*

 

3

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**THE SERVICEMASTER COMPANY**

## **Condensed Consolidated Statements of FinancialPosition (Unaudited)**

*(Inthousands, except share data)*

 
| ** **                                                                   | ** ** | **Successor**                      | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                   | ** ** | **As of March 31,** | ** ** | **As of December 31,** | ** ** |
| ** **                                                                   | ** ** | **2008**                           | ** ** | **2007** | ** ** |
| **Assets**                                                                   |       |                               |       |   |   |
| **Current Assets:**                                                          |       |                               |       |   |   |
| Cash and cash equivalents                                                    |       | $                                  | 155,195    |   | $ | 207,219 |   |
| Marketable securities                                                        |       | 88,857                             |       | 108,816 |   |
| Receivables, less allowance of  $20,104 and $20,994, respectively            |       | 324,756                            |       | 336,068 |   |
| Inventories                                                                  |       | 83,329                             |       | 72,352 |   |
| Prepaid expenses and other  assets                                           |       | 80,901                             |       | 26,843 |   |
| Deferred customer acquisition  costs                                         |       | 58,540                             |       | 25,322 |   |
| Deferred taxes                                                               |       | 45,896                             |       | 48,177 |   |
| Assets of businesses held  pending sale and discontinued operations          |       | 36,276                             |       | 42,474 |   |
| Total Current Assets                                                         |       | 873,750                            |       | 867,271 |   |
| **Property and Equipment:**                                                  |       |                               |       |   |   |
| At cost                                                                      |       | 215,783                            |       | 210,144 |   |
| Less: accumulated depreciation                                               |       | (33,780                            | )          | (22,147 | ) |
| Net property and equipment                                                   |       | 182,003                            |       | 187,997 |   |
|                                                                         |       |                               |       |   |   |
| **Other Assets:**                                                            |       |                               |       |   |   |
| Goodwill                                                                     |       | 3,050,471                          |       | 3,049,923 |   |
| Intangible assets, primarily trade names, service marks and trademarks,  net |       | 3,136,060                          |       | 3,185,253 |   |
| Notes receivable                                                             |       | 24,799                             |       | 26,401 |   |
| Long-term marketable  securities                                             |       | 148,195                            |       | 152,974 |   |
| Other assets                                                                 |       | 35,829                             |       | 36,299 |   |
| Debt issuance costs                                                          |       | 75,697                             |       | 84,942 |   |
| Total Assets                                                                 |       | $                                  | 7,526,804  |   | $ | 7,591,060 |   |
|                                                                         |       |                               |       |   |   |
| **Liabilities and Shareholder’s Equity**                                |       |                               |       |   |   |
|                                                                         |       |                               |       |   |   |
| **Current Liabilities:**                                                     |       |                               |       |   |   |
| Accounts payable                                                             |       | $                                  | 130,768    |   | $ | 103,400 |   |
| Accrued liabilities:                                                         |       |                               |       |   |   |
| Payroll and related expenses                                                 |       | 71,123                             |       | 132,054 |   |
| Self-insured claims and  related expenses                                    |       | 81,549                             |       | 84,781 |   |
| Other                                                                        |       | 128,895                            |       | 138,049 |   |
| Deferred revenue                                                             |       | 493,928                            |       | 408,476 |   |
| Liabilities of businesses held  pending sale and discontinued operations     |       | 12,125                             |       | 12,983 |   |
| Current portion of long-term debt                                            |       | 89,185                             |       | 53,564 |   |
| Total Current Liabilities                                                    |       | 1,007,573                          |       | 933,307 |   |
|                                                                         |       |                               |       |   |   |
| **Long-Term Debt**                                                           |       | 4,067,698                          |       | 4,077,247 |   |
|                                                                         |       |                               |       |   |   |
| **Long-Term Liabilities:**                                                   |       |                               |       |   |   |
| Deferred taxes                                                               |       | 1,029,967                          |       | 1,079,500 |   |
| Liabilities of businesses held  pending sale and discontinued operations     |       | 7,640                              |       | 7,765 |   |
| Other long-term obligations,  primarily self-insured claims                  |       | 199,254                            |       | 189,707 |   |
| Total Long-Term Liabilities                                                  |       | 1,236,861                          |       | 1,276,972 |   |
|                                                                         |       |                               |       |   |   |
| **Commitments and Contingencies (See Note 5)**                               |       |                               |       |   |   |
|                                                                         |       |                               |       |   |   |
| **Shareholder’s Equity:**                                               |       |                               |       |   |   |
| Common stock $0.01 par value, authorized 1,000 shares; issued 1,000  shares  |       | —                             |       | — |   |
| Additional paid-in capital                                                   |       | 1,433,064                          |       | 1,431,400 |   |
| Retained deficit                                                             |       | (199,362                           | )          | (123,520 | ) |
| Accumulated other  comprehensive loss                                        |       | (19,030                            | )          | (4,346 | ) |
| Total Shareholder’s Equity                                              |       | 1,214,672                          |       | 1,303,534 |   |
| Total Liabilities and  Shareholder’s Equity                             |       | $                                  | 7,526,804  |   | $ | 7,591,060 |   |

 

*See accompanying Notes to theCondensed Consolidated Financial Statements*

 

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**THE SERVICEMASTER COMPANY**

## **Condensed Consolidated Statements of Cash Flows(Unaudited)**

*(In thousands)*

 
| ** **                                                                  | ** ** | **Successor**                | ** ** | ** ** | **Predecessor**              | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------|------------|------------|------------------------------|------------|
| ** **                                                                  | ** ** | **Three**                    | ** ** | ** ** | **Three**                    | ** ** |
| ** **                                                                  | ** ** | **months ended**        | ** ** | ** ** | **months ended**        | ** ** |
| ** **                                                                  | ** ** | **March 31, 2008** | ** ** | ** ** | **March 31, 2007** | ** ** |
| **Cash and Cash Equivalents at Beginning of Period**                        |       | $                            | 207,219    |       |                         | $          | 123,675 |   |
|                                                                        |       |                         |       |       |                         |       |
| **Cash Flows from Operating Activities from Continuing Operations:**        |       |                         |       |       |                         |       |
| **Net (Loss) Income**                                                       |       | (75,842                      | )          |       | 8,549                        |       |
| Adjustments to reconcile net (loss) income to net cash provided from        |       |                         |       |       |                         |       |
| operating activities:                                                       |       |                         |       |       |                         |       |
| Loss from discontinued operations                                           |       | 748                          |       |       | 1,499                        |       |
| Depreciation expense                                                        |       | 12,558                       |       |       | 12,030                       |       |
| Amortization expense                                                        |       | 50,676                       |       |       | 2,266                        |       |
| Amortization of debt issuance costs                                         |       | 9,245                        |       |       | 569                          |       |
| Option and restricted stock expense                                         |       | 1,664                        |       |       | 1,555                        |       |
| Restructuring charges                                                       |       | 3,325                        |       |       | 7,058                        |       |
| Cash payments related to restructuring charges                              |       | (13,874                      | )          |       | (2,549                       | )          |
| Merger related charges                                                      |       | 50                           |       |       | 2,540                        |       |
| Change in working capital, net of acquisitions:                             |       |                         |       |       |                         |       |
| Current and deferred income taxes                                           |       | (31,407                      | )          |       | (10,074                      | )          |
| Receivables                                                                 |       | 12,971                       |       |       | (9,314                       | )          |
| Inventories and other current assets                                        |       | (95,764                      | )          |       | (84,340                      | )          |
| Accounts payable                                                            |       | 28,326                       |       |       | 153                          |       |
| Deferred revenue                                                            |       | 84,953                       |       |       | 62,787                       |       |
| Accrued liabilities                                                         |       | (54,835                      | )          |       | (30,378                      | )          |
| Other, net                                                                  |       | 1,676                        |       |       | 1,501                        |       |
| **Net Cash Used for Operating Activities from Continuing Operations**       |       | (65,530                      | )          |       | (36,148                      | )          |
|                                                                        |       |                         |       |       |                         |       |
| **Cash Flows from Investing Activities from Continuing Operations:**        |       |                         |       |       |                         |       |
| Property additions                                                          |       | (9,049                       | )          |       | (12,244                      | )          |
| Sale of equipment and other assets                                          |       | 711                          |       |       | 146                          |       |
| Acquisition of The ServiceMaster Company                                    |       | (16,163                      | )          |       | (1,462                       | )          |
| Other business acquisitions, net of cash acquired                           |       | (4,385                       | )          |       | (13,312                      | )          |
| Notes receivable, financial investments and securities                      |       | 14,370                       |       |       | 405                          |       |
| **Net Cash Used for Investing Activities from Continuing Operations**       |       | (14,516                      | )          |       | (26,467                      | )          |
|                                                                        |       |                         |       |       |                         |       |
| **Cash Flows from Financing Activities from Continuing Operations:**        |       |                         |       |       |                         |       |
| Borrowings of debt                                                          |       | 76,350                       |       |       | 352,901                      |       |
| Payments of debt                                                            |       | (52,793                      | )          |       | (292,624                     | )          |
| Shareholders’ dividends                                                |       | —                       |       |       | (34,990                      | )          |
| Proceeds from employee share plans                                          |       | —                       |       |       | 26,527                       |       |
| ** **                                                                  |       |                         |       |       |                         |       |
| **Net  Cash Provided from Financing Activities from Continuing Operations** |       | 23,557                       |       |       | 51,814                       |       |
| **Cash Flows from Discontinued Operations:**                                |       |                         |       |       |                         |       |
| Cash provided from operating activities                                     |       | 4,560                        |       |       | 1,328                        |       |
| Cash used for investing activities                                          |       | (44                          | )          |       | (109                         | )          |
| Cash used for financing activities                                          |       | (51                          | )          |       | (82                          | )          |
| **Net Cash Provided from Discontinued Operations**                          |       | 4,465                        |       |       | 1,137                        |       |
|                                                                        |       |                         |       |       |                         |       |
| **Cash Decrease During the Period**                                         |       | (52,024                      | )          |       | (9,664                       | )          |
|                                                                        |       |                         |       |       |                         |       |
| **Cash and Cash Equivalents at End of Period**                              |       | $                            | 155,195    |       |                         | $          | 114,011 |   |

 

*See accompanying Notes to the Condensed Consolidated FinancialStatements*

 

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# **THE SERVICEMASTER COMPANY**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

** **

**Note 1.Basis of Presentation**

** **

The condensedconsolidated financial statements include the accounts of The ServiceMasterCompany and its subsidiaries, collectively referred to as the “Company” or “ServiceMaster”.

 

On March 18, 2007, ServiceMaster entered into an Agreement andPlan of Merger (the “Merger Agreement”) with ServiceMaster Global Holdings, Inc.(formerly CDRSVM Topco, Inc.) (“Holdings”) and CDRSVM Acquisition Co., Inc.,an indirect wholly owned subsidiary of Holdings (“Acquisition Co.”). The MergerAgreement provided that, upon the terms and subject to the conditions set forthin the Merger Agreement, Acquisition Co. would merge with and intoServiceMaster, with ServiceMaster as the surviving corporation (the “Merger”).

 

On July 24, 2007 (the “Closing Date”), the Merger was completed,and each issued and outstanding share of ServiceMaster common stock, other thanshares held by ServiceMaster or Holdings or their subsidiaries and shares heldby stockholders who validly perfected their appraisal rights under Delawarelaw, was converted into the right to receive $15.625 in cash (the “MergerConsideration”). Each share of ServiceMaster common stock owned by ServiceMaster,Holdings or Acquisition Co. or any of their respective direct or indirectwholly-owned subsidiaries was cancelled and retired, and no consideration waspaid in exchange for it.

 

Although ServiceMaster continued asthe same legal entity after the Merger, the accompanying condensed consolidatedfinancial statements are presented for two periods: Predecessor and Successor,which relate to the period preceding the Merger and the period succeeding theMerger, respectively. The Company refers to the operations of ServiceMaster forboth the Predecessor and Successor periods. The condensed consolidatedstatements of financial position as of March 31, 2008 and December 31,2007 and the condensed consolidated statements of operations and of cash flowsfor the three months ended March 31, 2008 reflect the financial position,operations and cash flows of the Successor. The condensed consolidatedstatements of operations and of cash flows for the three months ended March 31,2007 reflect the operations and cash flows of the Predecessor.

 

As a result of the consummation of the Merger and the application of purchaseaccounting described in Note 3, the condensed consolidated financial statementsfor the Predecessor and Successor are not comparable.

 

The condensed consolidatedfinancial statements have been prepared by the Company in accordance withgenerally accepted accounting principles in the United States (“GAAP”) andpursuant to the rules and regulations of the Securities and ExchangeCommission. The Company recommends that the quarterly condensed consolidatedfinancial statements be read in conjunction with the consolidated financialstatements and the notes thereto included in the Company’s Annual Report on Form 10-Kfiled with the Securities and Exchange Commission for the year ended December 31,2007 (“2007 Annual Report”). The condensed consolidated financial statementsreflect all adjustments which are, in the opinion of management, necessary forthe fair presentation of the financial position, results of operations and cashflows for the interim periods presented. All intercompany transactions andbalances have been eliminated in consolidation. The financial results as well as the assets and liabilities related toInStar have been classified in the financial statement caption “businesses heldpending sale and discontinued operations” in all periods due to theclassification of InStar as held for sale in 2007.  The results of operations for any interimperiod are not necessarily indicative of the results which might be achievedfor a full year.

 

6

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**Note 2. Significant Accounting Policies**

 

TheCompany has identified the most important accounting policies with respect toits financial position and results of operations. These relate primarily torevenue recognition and the deferral of customer acquisition costs. Thefollowing revenue recognition policies have not changed from those disclosed inthe 2007 Annual Report.

 

Revenuesfrom lawn care and pest control services, as well as liquid and fumigationtermite applications, are recognized as the services are provided. Revenuesfrom landscaping services are recognized as they are earned based upon contractarrangements or when services are performed for non-contractual arrangements.The Company eradicates termites through the use of baiting systems, as well asthrough non-baiting methods (e.g., fumigation or liquid treatments). Termiteservices using baiting systems, termite inspection and protection contracts, aswell as home warranty services, are frequently sold through annual contractsfor a one-time, upfront payment. Direct costs of these contracts (service costsfor termite contracts and claim costs for warranty contracts) are expensed asincurred. The Company recognizes revenue over the life of these contracts inproportion to the expected direct costs. Those costs bear a direct relationship to the fulfillment of the Company’sobligations under the contracts and are representative of the relative valueprovided to the customer (proportional performance method).  Home warranty contract revenue is recognizedbased on the expected emergence of total claim costs.  The Company regularly reviews its estimatesof direct costs for its termite bait and home warranty contracts and adjuststhe estimates when appropriate. Revenue from trade name licensing arrangements isrecognized when earned.  The Company hasfranchise agreements in its TruGreen LawnCare, Terminix, ServiceMaster Clean,Merry Maids, AmeriSpec and Furniture Medic businesses. Franchise revenue (whichin the aggregate represents approximately five percent of consolidated revenuefrom continuing operations) consists principally of continuing monthly feesbased upon the franchisee’s customer level revenue. Monthly fee revenue isrecognized when the related customer level revenue is reported by thefranchisee and collectibility is assured. Franchise revenue also includesinitial fees resulting from the sale of a franchise. These fees are fixed andare recognized as revenue when collectibility is assured and all materialservices or conditions relating to the sale have been substantially performed.Total profits from the franchised operations (excluding trade name licensing)were approximately $14 million and $12 million for the three months ended March 31,2008 and 2007, respectively, and consolidated operating (loss) income fromcontinuing operations was approximately ($10 million) and $25 million for thethree months ended March 31, 2008 and 2007, respectively. The portion oftotal franchise fee income related to initial fees received from the sale offranchises was immaterial to the Company’s consolidated financial statementsfor all periods.

 

The Company had $494million and $408 million of deferred revenue at March 31, 2008 and December 31,2007, respectively. Deferred revenue consists primarily of payments receivedfor annual contracts relating to home warranty, termite, pest control and lawncare services.

 

Customer acquisitioncosts, which are incremental and direct costs of obtaining a customer, aredeferred and amortized over the life of the related contract in proportion torevenue recognized. These costs include sales commissions and direct sellingcosts which can be shown to have resulted in a successful sale.

 

TruGreen LawnCare hassignificant seasonality in its business. In the winter and spring, thisbusiness sells a series of lawn applications to customers which are renderedprimarily in March through October (the production season). Thisbusiness incurs incremental selling expenses at the beginning of the year thatdirectly relate to successful sales for which the revenues are recognized inlater quarters. On an interim basis, TruGreen LawnCare defers these incrementalselling expenses, pre-season advertising costs and annual repairs andmaintenance procedures that are performed primarily in the first quarter. Thesecosts are deferred and recognized in proportion to the contract revenue overthe production season, and are not deferred beyond the calendar year-end. Otherbusiness segments of the Company also defer, on an interim basis, advertisingcosts incurred early in the year. These costs are deferred and recognizedapproximately in proportion to revenue over the balance of the year, and arenot deferred beyond the calendar year-end.

 

7

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The cost ofdirect-response advertising at Terminix and TruGreen LawnCare, consistingprimarily of direct-mail promotions, is capitalized and amortized over itsexpected period of future benefits.

 

Thefair values of the Company’s financial instruments reflect the amounts thatwould be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date (exitprice). The fair value estimates presented in this report are based oninformation available to the Company as of March 31, 2008 and December 31,2007.

 

The preparation of thecondensed consolidated financial statements requires management to make certainestimates and assumptions required under GAAP which may differ from actualresults. Disclosures in the 2007 Annual Report presented the significant areasthat require the use of management’s estimates and discussed how managementformed its judgments. The areas discussed included revenue recognition; theallowance for uncollectible receivables; accruals for self-insured retentionlimits related to medical, workers’ compensation, auto and general liabilityinsurance claims; accruals for home warranty and termite damage claims; thepossible outcome of outstanding litigation; accruals for income tax liabilitiesas well as deferred tax accounts; the deferral and amortization of customeracquisition costs; useful lives for depreciation and amortization expense; andthe valuation of tangible and intangible assets.

 

**Note 3. Acquisition of ServiceMaster**

** **

As discussed in Note 1, the Merger was completed on July 24,2007.

 

Immediately following the completion of the Merger, all of theoutstanding capital stock of Holdings, the ultimate parent company ofServiceMaster, was owned by investment funds sponsored by, or affiliates of,Clayton, Dubilier & Rice, Inc. (“CD&R”), Citigroup PrivateEquity L.P., BAS Capital Funding Corporation and J.P. Morgan VenturesCorporation (collectively, the “Equity Sponsors”).

 

Equity contributions totaling $1,431 million from the EquitySponsors, together with (i) borrowings under a new $1,150 millionsenior unsecured interim loan facility (“Interim Loan Facility”), (ii) borrowingsunder a new $2,650 million senior secured term loan facility, and (iii) cashon hand at ServiceMaster, were used, among other things, to finance theaggregate Merger Consideration, to make payments in satisfaction of otherequity-based interests in ServiceMaster under the Merger Agreement, to settleexisting interest rate swaps, to redeem or provide for the repayment of certainof the Company’s existing indebtedness and to pay related transaction fees andexpenses. In addition, letters of credit issued under a new $150 millionpre-funded letter of credit facility (together with the senior secured termloan facility, the “Term Facilities”) were used to replace and/or secureletters of credit previously issued under a ServiceMaster credit facility thatwas terminated as of the Closing Date. On the Closing Date, the Company alsoentered into, but did not draw under, a new $500 million senior securedrevolving credit facility (the “Revolving Credit Facility”).

 

In connection with the Merger and the related transactions (the “Transactions”),ServiceMaster retired certain of its existing indebtedness, includingServiceMaster’s $179.0 million, 7.875% notes due August 15, 2009 (the“2009 Notes”). On the Closing Date, the 2009 Notes were called for redemptionand they were redeemed on August 29, 2007. Additionally, the Companyutilized a portion of the proceeds from the Term Facilities to repay atmaturity ServiceMaster’s $49.2 million, 6.95% notes due August 15, 2007.

 

See Note 14 to the consolidated financial statements in the 2007Annual Report for a description of the Company’s indebtedness.

 

The Company accounted for the Merger in accordance with SFAS No. 141,“Business Combinations”, which requires the cost of the Merger to be allocatedto the assets and liabilities of the 

 

8

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Companybased on fair value. The Merger and the allocation of the purchase price havebeen recorded as of July 25, 2007.

 

The excess of the purchase price over the net tangible and intangibleassets acquired was recorded as goodwill. The Company recorded purchaseaccounting adjustments to increase the carrying value of property, to establishintangible assets for trade names, service marks and trademarks (“trade names”),customer relationships, franchise agreements, backlog and lease commitments,among other things, as well as to reduce to fair value deferred revenue anddeferred customer acquisition costs.

 

Allocation of the purchase price for the Merger of the Company wasbased on estimates of the fair value of net assets acquired. The purchase priceallocation is subject to finalization of the assessment of the fair value ofproperty and equipment and transaction costs. Revisions to the preliminarypurchase price allocation will be made as additional information becomesavailable, but such revisions are not expected to be material to the Company’sbalance sheet or results of operations. The Company expects to finalize theallocation of the purchase price during the second quarter of 2008.

 

Thepurchase price has been allocated on a preliminary basis as follows:

 
| **(In millions)**                                        | ** ** | ** ** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|
| Purchase  consideration                                       |       | $          | 4,891      |   |
| Net assets  acquired (historical basis)                       |       | (1,262     | )          |
| Purchase price  in excess of historical assets                |       | $          | 3,629      |   |
| Identifiable  intangible assets:                              |       |       |       |
| Trade names                                                   |       | $          | 2,484      |   |
| Customer  relationships                                       |       | 652        |       |
| Franchise  agreements                                         |       | 88         |       |
| Backlog                                                       |       | 68         |       |
| Subcontractor  and realtor network                            |       | 10         |       |
| Favorable lease  commitments                                  |       | 10         |       |
| Software                                                      |       | 17         |       |
| Total  identifiable intangible assets                         |       | 3,329      |       |
| Eliminate historical  basis of identifiable intangible assets |       | (249       | )          |
| Net adjustment  to identifiable intangible assets             |       | 3,080      |       |
| Goodwill                                                      |       | 1,375      |       |
| Current assets  (deferred customer acquisition costs)         |       | (68        | )          |
| Current  liabilities (primarily deferred revenue)             |       | 94         |       |
| Fixed assets                                                  |       | 29         |       |
| Fair value  adjustment to existing debt                       |       | 88         |       |
| Other  non-current liabilities                                |       | (5         | )          |
| Historical debt  issuance fees written off                    |       | (16        | )          |
| Deferred taxes                                                |       | (951       | )          |
| Other                                                         |       | 3          |       |
| Allocation of  purchase price in excess of historical assets  |       | $          | 3,629      |   |

 

Goodwill and most trade names are indefinite-lived intangible assets.As a result, goodwill and indefinite-lived trade names will not be amortizedbut will be evaluated for impairment at least annually.

 

TheCompany incurred certain costs related to the Merger that are presented as “Mergerrelated charges” in the Condensed Consolidated Statements of Operations and arerecorded in the Other Operations and Headquarters business segment.

 

9

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**Note 4.Restructuring Charges**

 

The Company is engaged in a reorganization and restructuring of certainof its businesses and support functions (“Fast Forward”). Among the purposes ofFast Forward is to eliminate layers and bureaucracy and simplify work processesin order to better align the Company’s work processes around its operationaland strategic objectives. It is expected that Fast Forward will be effected inphases. The first phase involves, among other things, a reduction in work forceand various process improvements, including the closing of American Home Shield’scall center located in Santa Rosa, California. The second phase is expected toinclude the organization of certain corporate support functions into Centers ofExcellence (“COE”s) which are expected to deliver higher quality services toour business units at lower costs, the outsourcing to third party vendors ofvarious business activities that currently are handled internally, as well asother employee workforce reductions expected to result in cost-savings. Thefirst phase of Fast Forward was substantially completed in the first quarter of2008, and the second phase is expected to begin implementation in the secondhalf of 2008.

 

In connection with Fast Forward, the Company incurred costs in thethree months ended March 31, 2008 of approximately $2.6 million. Suchcosts include consulting fees of approximately $1.6 million and severanceand other costs of approximately $1.0 million. No restructuring chargesrelated to Fast Forward were incurred in the three months ended March 31,2007.

 

The 2007 firstquarter results include restructuring charges related to the Company’sconsolidation of its corporate headquarters into its operations support centerin Memphis, Tennessee and the closing of its headquarters in Downers Grove,Illinois.  The transition to Memphiswas substantially completed in 2007. Almost all costs related to the transition were cash expenditures, and,in accordance with GAAP, these costs were expensed throughout the transitionperiod.  In the three months ended March 31,2007, the Company recognized charges of approximately $7.1 million.  These charges consisted of $6.1 million ofemployee retention and severance and $1.0 million of recruiting and relatedcosts.

 

During the three months ended March 31, 2008, the Company incurredan additional $0.7 million relating to this relocation, which includesadditional severance and other costs.

 

Thepretax charges discussed above are reported in the “Restructuring charges” linein the Condensed Consolidated Statements of Operations.

 

**Note 5.Commitments and Contingencies**

** **

The Company carriesinsurance policies on insurable risks at levels that it believes to beappropriate, including workers’ compensation, auto and general liabilityrisks.  The Company has both self-insuredretention limits and layers of excess insurance coverage above suchself-insured retention limits that is insured by third parties.  The Company is required to pay all claimsthat fall below the retention limits.  Asof March 31, 2008 and December 31, 2007, the Company had totalaccrued self-insured claims of $154 million and $159 million,respectively.  During the three monthsended March 31, 2008 and 2007, the Company recorded provisions foruninsured claims totaling $8 million and $12 million, respectively, and theCompany paid claims totaling $14 million and $16 million, respectively.  The Company uses historical claims experienceto establish both the current year accrual and the underlying provision forfuture losses.  This actuarially determinedprovision and related accrual includes both known claims, as well as incurredbut not reported claims.  The Companyadjusts its estimate of accrued self-insured claims when required to reflectchanges based on factors such as changes in health care costs, accidentfrequency and claim severity.

 

Accruals for warrantyclaims in the American Home Shield business are made based on the Company’sclaims experience and actuarial projections. Termite damage claim accruals are recorded based on both the historicalrates of claims incurred within a contract year and the cost per claim.  Current activity could differ causing achange in estimates.  The Company hascertain liabilities with respect to existing or potential claims, lawsuits, andother proceedings.  The Company accruesfor these 

 

10

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liabilities when it isprobable that future costs will be incurred and such costs can be reasonablyestimated.  Any resulting adjustments,which could be material, are recorded in the period the adjustments areidentified.

 

The Company has guarantees on certain bonds issued by divestedcompanies, primarily performance type bonds. The maximum payments the Companycould be required to make if the buyers are unable to fulfill their obligationsis approximately $9 million at March 31, 2008. All of the bonds arescheduled to expire in 2008, but may be extended depending on the completion ofthe related projects. The Company believes that if it were to incur a loss onany individual bond guarantee, the likelihood of which the Company believes isremote, such loss would not have a material effect on the Company’s business,financial condition, annual results of operations or cash flows.

 

In the ordinary course ofconducting its business activities, the Company becomes involved in judicial,administrative and regulatory proceedings involving both private parties andgovernmental authorities.  These proceedingsinclude general and commercial liability and employment actions as well as asmall number of environmental proceedings. The Company does not expect any ofthese proceedings to have a material effect on the Company’s business,financial condition, annual results of operations or cash flows.

 

**Note 6.Goodwill and Intangible Assets**

** **

Inaccordance with SFAS No. 142, “Goodwill and Other Intangible Assets”,goodwill and intangible assets that are not amortized are subject to assessmentfor impairment by applying a fair-value based test on an annual basis or morefrequently if circumstances indicate a potential impairment. The Company’sannual assessment date is October 1.

 

The table below summarizes the goodwill balances by segment forcontinuing operations:

 
| **(In  thousands)**             | ** ** | **TruGreen  LawnCare** | ** ** | **TruGreen  LandCare** | ** ** | **Terminix** | ** ** | **American  Home  Shield** | ** ** | **Other  Operations  &  Headquarters** | ** ** | **Total** | ** ** |
|---------------------------------|------------|------------------------|------------|------------------------|------------|--------------|------------|----------------------------|------------|--------------------------------------------|------------|-----------|------------|
| Balance at  Dec. 31, 2007  |       | $                      | 1,143,670  |                   | $          | 47,872       |       | $                          | 1,323,953  |                                       | $          | 350,079   |       | $ | 184,349 |   | $ | 3,049,923 |   |
| Acquisitions                    |       | 1,992                  |       | —                 |       | 2,122        |       | —                     |       | —                                     |       | 4,114     |       |
| Other (1)                       |       | (1,420                 | )          | (572                   | )          | (1,539       | )          | (581                       | )          | 546                                        |       | (3,566    | )          |
| Balance at  March 31, 2008 |       | $                      | 1,144,242  |                   | $          | 47,300       |       | $                          | 1,324,536  |                                       | $          | 349,498   |       | $ | 184,895 |   | $ | 3,050,471 |   |

 

----

(1) Primarilyreflects adjustments to the preliminary purchase price allocation related tothe Merger.  Also reflects the impact ofthe resolution of certain tax items and the amortization of tax deductiblegoodwill.

 

Thetable below summarizes the other intangible asset balances for continuingoperations:

 
| ** **                | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|--------------------|------------|-----------------------|------------|
| **(In thousands)**   | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Trade names(1)            |       | $                  | 2,468,200  |                  | $          | 2,468,200 |   |
| Other intangible  assets  |       | 851,196            |       | 849,715               |       |
| Accumulated  amortization |       | (183,336           | )          | (132,662              | )          |
| Net other  intangibles    |       | 667,860            |       | 717,053               |       |
| Total                     |       | $                  | 3,136,060  |                  | $          | 3,185,253 |   |

 

----

(1)                                  Not subject toamortization.

 

11

**Note 7. Stock-Based Compensation**

 

Duringthe Successor three months ended March 31, 2008 and the Predecessor threemonths ended March 31, 2007, share-based compensation expense wasapproximately $1.7 million ($1.2 million after-tax) and $1.6 million ($1.0 millionafter-tax), respectively.

 

Asof March 31, 2008, there was approximately $25.8 million of totalunrecognized compensation cost related to non-vested options to purchase sharesof Holdings stock. These remaining costs are expected to be recognized over theremaining 3.7 years of the four-year requisite service period.

 

**Note 8.Supplemental Cash Flow Information**

 

In the CondensedConsolidated Statements of Cash Flows, the caption Cash and Cash Equivalentsincludes investments in short-term, highly-liquid securities having a maturityof three months or less when purchased. Supplemental information relating tothe Condensed Consolidated Statements of Cash Flows for the Successor threemonths ended March 31, 2008 and the Predecessor three months ended March 31,2007 is presented in the following table:

 
| ** **                                                     | ** ** | **Successor**                | ** ** | **Predecessor**              | ** ** |
|----------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                     | ** ** | **Three**                    | ** ** | **Three**                    | ** ** |
| **(In thousands)**                                        | ** ** | **months ended**        | ** ** | **months ended**        | ** ** |
| **Cash paid for or (received from):** | ** ** | **March 31, 2008** | ** ** | **March 31, 2007** | ** ** |
| Interest expense                                               |       | $                            | 90,149     |                         | $          | 25,444 |   |
| Interest and investment income                                 |       | (2,636                       | )          | (8,981                       | )          |
| Income taxes, net of refunds                                   |       | 775                          |       | 15,900                       |       |
|                                                                |            |                              |            |                              |            |  |  |

 

Cash received frominterest and investment income primarily reflects investment income and gainsrealized on the investment portfolio at American Home Shield.

 

**Note 9.Comprehensive Income**

 

Total comprehensive losswas $14.7 million for the Successor three months ended March 31, 2008 and$10 million for the Predecessor three months ended March 31, 2007. Totalcomprehensive income primarily includes net income, unrealized gains/(losses)on marketable securities, unrealized gains/(losses) on derivative instrumentsand the effect of foreign currency translation.

 

**Note 10. Receivable Sales**

 

TheCompany has an arrangement to provide for the ongoing revolving sale of adesignated pool of accounts receivable of TruGreen LawnCare and Terminix to awholly-owned, bankruptcy-remote subsidiary, ServiceMaster FundingCompany LLC. ServiceMaster Funding Company LLC has entered into anarrangement pursuant to which it may transfer, on a revolving basis, anundivided percentage ownership interest in a pool of accounts receivable tounrelated third party purchasers. ServiceMaster Funding Company LLCretains an undivided percentage interest in the pool of accounts receivable andbad debt losses for the entire pool are allocated first to this retainedinterest. During the Successor three months ended March 31, 2008 and thePredecessor three months ended March 31, 2007, there were no receivablessold to third parties under this arrangement. However, the Company may sell itsreceivables in the future which would provide an alternative funding source.The arrangement is a 364-day facility that is renewable at the option ofServiceMaster Funding Company LLC, with a final termination date of July 17,2012. The Company may sell up to $70 million of its receivables to thesepurchasers and therefore has immediate access to cash proceeds from thesesales. The amount of the eligible receivables varies during the year based onseasonality of the business and could, at times, limit the amount available tothe Company. There is presently only one purchaser that is required to purchasereceivables under the arrangement.  Ifthis purchaser were to exercise its right to terminate its participation in thearrangement, which it may do in the third quarter of each year, the amount ofcash available to the Company may be reduced or eliminated.

 

12

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**Note 11. Cash and MarketableSecurities**

 

Gainsand losses on sales of investments, as determined on a specific identificationbasis, are included in investment income in the period they are realized. TheCompany periodically reviews its portfolio of investments to determine whetherthere has been an other than temporary decline in the value of the investmentsfrom factors such as deterioration in the financial condition of the issuer orthe market(s) in which it competes. The Company recorded an impairmentcharge of approximately $5.2 million ($3.7 million after-tax) and $0.6 million($0.4 million after-tax) during the three months ended March 31, 2008and 2007, respectively, due to other than temporary declines in the value ofcertain investments..  The unrealizedgains in the investment portfolio were approximately $8.2 million and$18.2 million as of March 31, 2008 and 2007, respectively. Unrealizedlosses were approximately $5.3 million and $2.5 million as of March 31,2008 and 2007, respectively.  There wereno unrealized losses older than one year at March 31, 2008. There wereapproximately $1.3 million of unrealized losses older than one year at March 31,2007.  The aggregate fair value of theinvestments with unrealized losses totaled $43.6 million and$85.4 million at March 31, 2008 and 2007, respectively.  The Company’s marketable securities consistprimarily of corporate bonds and common equity securities.

 

**Note 12. Long-Term Debt**

 

Long-term debt at March 31,2008 and December 31, 2007 is summarized in the following table:

 
| **(In thousands)**                                  | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Senior secured term loan facility maturing in 2014       |       | $                        | 2,630,125  |                        | $          | 2,636,750 |   |
| Senior unsecured interim loan facility maturing in  2008 |       | 1,150,000                |       | 1,150,000                   |       |
| Revolving credit facility maturing in 2013               |       | 45,000                   |       | —                      |       |
| 7.10% notes maturing in 2018 (1)                         |       | 60,201                   |       | 59,772                      |       |
| 7.45% notes maturing in 2027 (1)                         |       | 143,140                  |       | 142,457                     |       |
| 7.25% notes maturing in 2038 (1)                         |       | 58,393                   |       | 58,206                      |       |
| Other                                                    |       | 70,024                   |       | 83,626                      |       |
| Less current portion                                     |       | (89,185                  | )          | (53,564                     | )          |
| Total long-term debt                                     |       | $                        | 4,067,698  |                        | $          | 4,077,247 |   |

 

----

(1)           The increase from the balance at December 31,2007 reflects the amortization of fair value adjustments related to purchaseaccounting, which increases the effective interest rate from the coupon ratesshown above.

 

TheInterim Loan Facility will mature on July 24, 2008. On the maturity date(or at the election of the Company following the completion of a standard highyield road show after which no senior notes to refinance in whole or part theInterim Loan Facility loans were issued) outstanding amounts under the InterimLoan Facility shall be converted into 10.75%/11.50% senior toggle notes due2015 (“Permanent Notes”). The Permanent Notes would be issued pursuant to arefinancing indenture. In connection with the issuance of Permanent Notes,ServiceMaster would enter into a registration rights agreement to be dated thedate of the issuance of the Permanent Notes, pursuant to which ServiceMasterwill be required to file a shelf registration statement (or, at ServiceMaster’soption, an exchange offer registration statement) with respect to the PermanentNotes.

 

InFebruary 2008, the Company entered into two 3-year interest rate swapagreements and one 4-year interest rate swap agreement, effective March 3,2008. The total notional amount of the 3-year 

 

13

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agreementswas $250 million and the total notional amount of the 4-year swapagreement was $250 million. Under the terms of the agreements, the Companywill pay a weighted average fixed rate of interest of approximately 3.15% onthe $250 million notional amount of 3-year swap agreements and 3.48% onthe 4-year swap agreement. The Company will receive a floating rate of interest(based on three month LIBOR) on the notional amount. Therefore, the effectiveinterest rate for $500 million of the term loans is fixed at a ratebetween 5.90% and 6.23%, including the borrowing margin described inNote 14 to the consolidated financial statements in the 2007 AnnualReport. In accordance with SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities”, these interest rate swap agreements areclassified as cash flow hedges and, as such, the hedging instruments arerecorded on the balance sheet as either an asset or liability at fair value,with the effective portion of the changes in fair value attributable to thehedged risks recorded in other comprehensive income.

 

**Note 13. Businesses Held PendingSale and Discontinued Operations**

 

Reported“loss from businesses held pending sale and discontinued operations, net ofincome taxes” for all periods presented include the operating results of thesold and discontinued businesses noted in the 2007 Annual Report. The operatingresults and financial position of discontinued operations are as follows:

 
| ** **                                                          | ** ** | **Successor**                    | ** ** | **Predecessor**                  | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                          | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
| **(In thousands)**                                             | ** ** | **March 31, 2008**     | ** ** | **March 31, 2007**     | ** ** |
| Operating  Results:                                                 |       |                             |       |                             |       |
| Operating  revenue                                                  |       | $                                | 17,806     |                             | $          | 22,400 |   |
| Operating income                                                    |       | (1,137                           | )          | (2,473                           | )          |
| Interest expense                                                    |       | (41                              | )          | (19                              | )          |
| Pretax loss                                                         |       | (1,178                           | )          | (2,492                           | )          |
| Benefit from  income taxes                                          |       | (430                             | )          | (993                             | )          |
| Loss from  businesses held pending sale and discontinued operations |       | $                                | (748       | )                                | $          | (1,499 | ) |

 
| ** **             | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Financial  Position:   |       |                     |       |                        |       |
| Current assets         |       | $                        | 36,276     |                        | $          | 42,474 |   |
| Current  liabilities   |       | 12,125                   |       | 12,983                      |       |
| Long-term  liabilities |       | 7,640                    |       | 7,765                       |       |
| Total  liabilities     |       | $                        | 19,765     |                        | $          | 20,748 |   |

 

Thetable below summarizes the activity during the three months ended March 31,2008 for the remaining liabilities from operations that were disposed of inyears prior to 2008. The remaining obligations primarily relate to long-termself-insurance claims. The Company believes that the remaining reservescontinue to be adequate and reasonable.

 
| **(In  thousands)**                                | ** ** | **Balance at  Dec. 31, 2007** | ** ** | **Cash Payments  or Other** | ** ** | **(Income)/  Expense** | ** ** | **Balance at  Mar. 31, 2008** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------|------------|------------------------|------------|----------------------------------------------|------------|
| Remaining  liabilities of discontinued operations: |       |                                         |       |                                  |       |                   |       |                                         |       |
| ARS/AMS                                            |       | $                                            | 2,384      |                                  | $          | (134                   | )          | $                                            | 192        |   | $ | 2,442 |   |
| LandCare  Construction                             |       | 1,257                                        |       | (44                                   | )          | (17                    | )          | 1,196                                        |       |
| LandCare utility  line clearing business           |       | 1,350                                        |       | (48                                   | )          | —                 |       | 1,302                                        |       |
| Certified  Systems, Inc. and other            |       | 6,721                                        |       | 269                                   |       | —                 |       | 6,990                                        |       |
|                                                    |            |                                              |            |                                       |            |                        |            |                                              |            |  |  |  |  |

 

14

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**Note14. Income Taxes**

 

Asof March 31, 2008 and December 31, 2007, the Company had $14.2 million and$13.3 million, respectively, of tax items primarily reflected in state taxreturns that had not been recognized for financial reporting (“unrecognized taxbenefits”).  If recognized prior to December 31,2008, $12.6 million ($9.1 million, net of federal and state tax effects)would be recorded as a purchase accounting adjustment to goodwill and$1.6 million ($1.2 million, net of federal and state tax effects) wouldaffect the Company’s effective tax rate.

 

Upto $4.9 million of the Company’s unrecognized tax benefits could berecognized within the next twelve months. The Company recognized approximately$0.2 million of its unrecognized tax benefits during the Successor three monthsended March 31, 2008 and approximately $0.4 million during the Predecessorthree months ended March 31, 2007.

 

TheCompany files consolidated and separate income tax returns in the United Statesfederal jurisdiction and in many state and foreign jurisdictions.  The Company has been audited by the UnitedStates Internal Revenue Service (“IRS”) through 2005 and is no longer subjectto state and local or foreign income tax examinations by tax authorities foryears before 2001.

 

Inthe ordinary course, the Company is subject to review by domestic and foreigntaxing authorities, including the IRS. As previously disclosed, the U.S.federal tax returns filed by the Company through the 2005 return have beenreviewed by the IRS. The Company paid $5 million primarily in the firstquarter of 2006 relating to the resolution of the 2003 and 2004 audits. In thefourth quarter of 2006, the IRS completed the audit of the Company’s tax returnfor 2005, with no adjustments or additional payments. The IRS commencedexaminations of the Company’s U.S. federal income tax returns for 2006 and 2007in the first quarter of 2006 and 2007, respectively, which are anticipated tobe completed by the end of 2008. At this time, the outcome of these audits isnot known and no significant adjustments have been proposed by the IRSpertaining to these audit periods. Two state tax authorities are in the processof auditing state income tax returns of various subsidiaries. One state auditis at the appeals level. If state authorities were to prevail with theirassessments, the Company does not anticipate that these adjustments would havea material impact on the Company’s financial position, annual results ofoperations or cash flows.

 

TheCompany’s policy is to recognize potential interest and penalties related toits tax positions within the tax provision. During the Successor three monthsended March 31, 2008 and the Predecessor three months ended March 31,2007, the Company recognized interest expense of approximately$0.6 million and $0.1 million, respectively, through the taxprovision. As of March 31, 2008 and December 31, 2007, the Company hadaccrued for the payment of interest and penalties of approximately$3.3 million ($2.0 million, net of federal and state tax effects) and $2.4million ($1.4 million, net of federal and state tax effects), respectively.

 

***Note15. Business Segment Reporting***

* *

*Thebusiness of the Company is conducted through five reportablesegments: TruGreen LawnCare, TruGreen LandCare, Terminix, American HomeShield and Other Operations and Headquarters. The TruGreen LawnCare segment provides residential and commercial lawncare services.  The TruGreen LandCaresegment provides landscaping services primarily to commercial customers.  The Terminix segment provides termite andpest control services to residential and commercial customers. The AmericanHome Shield segment provides home warranties to consumers that cover HVAC,plumbing and other home systems and appliances. The Other Operations and Headquarters segment includes the franchisedand Company-owned operations of ServiceMaster Clean, AmeriSpec, Furniture Medicand Merry Maids, which provide primarily residential disaster restoration,commercial cleaning, carpet and upholstery cleaning, home inspection services,furniture repair and maid services.  TheOther Operations and Headquarters segment also includes the Company’sheadquarters*

* *

*15*

----

* *

*operations, which provide various technology,marketing, finance, legal and other support services to the business units.*

* *

*Segment information for continuingoperations is presented below.*

* *
| ** **                            | ** ** | **Successor**            | ** ** | **Predecessor**          | ** ** |
|---------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                            | ** ** | **Three**                | ** ** | **Three**                | ** ** |
| ** **                            | ** ** | **Months  Ended**        | ** ** | **Months  Ended**        | ** ** |
| **(In thousands)**               | ** ** | **March 31,  2008** | ** ** | **March 31,  2007** | ** ** |
| Operating  Revenue:                   |       |                     |       |                     |       |
| TruGreen  LawnCare                    |       | $                        | 134,442    |                     | $          | 132,672 |   |
| TruGreen  LandCare                    |       | 78,652                   |       | 102,942                  |       |
| Terminix                              |       | 261,648                  |       | 262,172                  |       |
| American Home  Shield                 |       | 105,418                  |       | 125,187                  |       |
| Other Operations  and Headquarters    |       | 52,071                   |       | 50,522                   |       |
| Total Operating  Revenue              |       | $                        | 632,231    |                     | $          | 673,495 |   |
| Operating (Loss)  Income:(1,2)        |       |                     |       |                     |       |
| TruGreen  LawnCare                    |       | (34,059                  | )          | (11,593                  | )          |
| TruGreen  LandCare                    |       | 2,091                    |       | 66                       |       |
| Terminix                              |       | 43,213                   |       | 44,771                   |       |
| American Home  Shield                 |       | (17,692                  | )          | 7,021                    |       |
| Other Operations  and Headquarters(2) |       | (3,855                   | )          | (15,203                  | )          |
| Total Operating  (Loss) Income        |       | $                        | (10,302    | )                        | $          | 25,062 |   |

 

(1)                                Presented below is a reconciliation ofsegment operating (loss) income to (loss) income from continuing operationsbefore income taxes.

 
| ** **                                                    | ** ** | **Successor**            | ** ** | **Predecessor**          | ** ** |
|---------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                                    | ** ** | **Three**                | ** ** | **Three**                | ** ** |
| ** **                                                    | ** ** | **Months  Ended**        | ** ** | **Months  Ended**        | ** ** |
| **(In  thousands)**                                           | ** ** | **March 31,  2008** | ** ** | **March 31,  2007** | ** ** |
| Segment Operating  (Loss) Income                              |       | $                        | (10,302    | )                        | $          | 25,062 |   |
| Non-operating  expense (income):                              |       |                     |       |                     |       |
| Interest expense                                              |       | 89,586                   |       | 14,264                   |       |
| Interest and net  investment loss (income)                    |       | 6,045                    |       | (8,066                   | )          |
| Minority  interest and other expense, net                     |       | 132                      |       | 2,049                    |       |
| (Loss) Income  from Continuing Operations before Income Taxes |       | $                        | (106,065   | )                        | $          | 16,815 |   |

 

(2)                                Theresults include restructuring charges for severance, as well as costsassociated with Fast Forward, and payments for employee retention and severancerelated to the Company’s decision to consolidate its corporate headquartersinto its operations support center in Memphis, Tennessee and close its formerheadquarters in Downers Grove, Illinois. The restructuring charges totaled$3.3 million in the three months ended March 31, 2008 and$7.1 million in the three months ended March 31, 2007. The resultsalso include Merger charges related to the purchase of ServiceMaster by a groupof investors led by Clayton, Dubilier & Rice, Inc. The Mergerrelated charges totaled $0.05 million pretax in the three months ended March 31,2008 and $2.5 million pretax in the three months ended March 31,2007.

 

16

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**Note16. Related Party Transactions**

 

Inconnection with the Transactions, the Company entered into a consultingagreement with Clayton, Dubilier & Rice, Inc. (“CD&R”) underwhich CD&R provides the Company with on-going consulting and managementadvisory services in exchange for an annual management fee of $2 million.  This fee is payable quarterly.  The Company recorded a management fee of $0.5million for the three months ended March 31,2008. There was no management fee recorded for the three months ended March 31,2007. The consulting agreement also provides that CD&R may receive futurefees in connection with certain subsequent financing and acquisition ordisposition transactions.

 

**Note 17.Newly Issued Accounting Statements and Positions**

 

InSeptember 2006, the Financial Accounting Standards Board (“FASB”) issuedSFAS 157, “Fair Value Measurement”. This Statement defines fair value,establishes a framework for measuring fair value in accordance with GAAP, andexpands disclosures about fair value measurements. There are no new fair valuemeasurements required. This Statement is effective for financial statementsissued for fiscal years beginning after November 15, 2007 for financialassets and liabilities and for fiscal years beginning after November 15,2008 for non-financial assets and liabilities. The Company has assessed theimpact of this Statement to the Company’s consolidated financial position,results of operations and cash flows. The Company has adopted this Statementfor financial assets and liabilities (See Note 18). The Company does not expectthe adoption of this Statement for non-financial assets and liabilities to havea material effect on these consolidated financial statements. In February 2008,the FASB approved the issuance of FASB Staff Position (FSP) FAS157-2. FSPFAS 157-2 defers the effective date of Statement No. 157 until January 1,2009 for nonfinancial assets and nonfinancial liabilities except those itemsrecognized or disclosed at fair value on an annual or more frequently recurringbasis.

 

InFebruary 2007, the FASB issued SFAS 159, “The Fair Value Option forFinancial Assets and Financial Liabilities”. This Statement permits entities tochoose to measure at fair value many financial instruments and certain otheritems such as investments, debt and derivative instruments. This statement iseffective for financial statements issued for fiscal years beginning after November 15,2007. The Company has elected not to apply the fair value option to any of itsfinancial assets or liabilities.

 

InDecember 2007, the FASB issued SFAS 141(R), “Business Combinations”.This Statement will significantly change the accounting for businesscombinations and is effective for business combinations finalized in fiscalyears beginning after December 15, 2008. SFAS No. 141(R) changesthe method for applying the accounting for business combinations in a number ofsignificant respects including the requirement to expense transaction fees andexpected restructuring costs as incurred, rather than including these amountsin the allocated purchase price; the requirement to recognize the fair value ofcontingent consideration at the acquisition date, rather than the expectedamount when the contingency is resolved; the requirement to recognize the fairvalue of acquired in-process research and development assets at the acquisitiondate, rather than immediately expensing; and the requirement to recognize again in relation to a bargain purchase price, rather than reducing theallocated basis of long-lived assets. Because this standard is generallyapplied prospectively, the effect of adoption on the Company’s financialstatements will depend primarily on specific transactions, if any, completedafter 2008. The Company is currently evaluating the effects that this statementis likely to have on potential post-2008 transactions.

 

InDecember 2007, the FASB issued SFAS 160, “Non-controlling Interestsin Consolidated Financial Statements—An Amendment of ARB No. 51”. ThisStatement establishes new accounting and reporting standards for thenon-controlling interest in a subsidiary and for the deconsolidation of asubsidiary. This Statement is effective for fiscal years beginning after December 15,2008. The Company is currently assessing the impact of this Statement on itsconsolidated financial statements.

 

17

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InMarch 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities – anamendment of FASB Statement No. 133”. This statement requiresadditional disclosures for derivative instruments and hedging activities thatinclude how and why an entity uses derivatives, how these instruments and therelated hedged items are accounted for under SFAS No. 133 and relatedinterpretations, and how derivative instruments and related hedged items affectthe entity’s financial position, results of operations and cash flows. Thisstatement is effective for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008. The Company iscurrently assessing the impact of this Statement on its consolidated financialstatements.

 

**Note 18.Fair Value of Financial Instruments**

 

The Company has estimated the fair value of itsfinancial instruments measured at fair value on a recurring basis using themarket and income approaches. For investments in marketable securities,deferred compensation trust assets and derivative contracts, which are carriedat their fair values, the Company’s fair value estimates incorporate quotedmarket prices, other observable inputs (for example, interest rates) andunobservable inputs (for example, forward commodity prices) at the balancesheet date.

 

Thecarrying amount, including accrued interest, and estimated fair value ofcertain of the Company’s financial instruments for the periods presented are as follows:

 
| ** **                            | ** ** | **March 31, 2008** | ** ** | **December 31, 2007**                             | ** ** |
|---------------------------------------|------------|------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                            | ** ** | ** **                   | ** ** | **Estimated Fair Value Measurements**        | ** ** | ** ** | ** ** |
| **(In thousands)**               | ** ** | **Carrying  Value**          | ** ** | **Quoted  Prices In  Active  Markets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** | **Carrying  Value** | ** ** | **Estimated  Fair Value** | ** ** |
| **Financial  Assets**                 |       |                         |       |                                                        |       |   |   |   |   |   |   |   |   |
| Deferred  compensation trust assets   |       | $                            | 27,028     |                                                        | $          | 27,028 |   | $ | — |   | $ | — |   | $ | 35,100 |   | $ | 35,100 |   |
| Investments in  marketable securities |       | 210,024                      |       | 106,305                                                     |       | 103,719 |   | — |   | 226,690 |   | 226,690 |   |
| Commodity price  swap contracts       |       | 3,118                        |       | —                                                      |       | — |   | 3,118 |   | — |   | — |   |
| Total financial  assets               |       | $                            | 240,170    |                                                        | $          | 133,333 |   | $ | 103,719 |   | $ | 3,118 |   | $ | 261,790 |   | $ | 261,790 |   |
|                                  |       |                         |       |                                                        |       |   |   |   |   |   |   |   |   |
| **Financial  Liabilities**            |       |                         |       |                                                        |       |   |   |   |   |   |   |   |   |
| Interest rate  swap contracts         |       | $                            | 38,562     |                                                        | $          | — |   | $ | 38,652 |   | $ | — |   | $ | 16,557 |   | $ | 16,557 |   |
| Total financial  liabilities          |       | $                            | 38,562     |                                                        | $          | — |   | $ | 38,652 |   | $ | — |   | $ | 16,557 |   | $ | 16,557 |   |

 

Areconciliation of the beginning and ending fair values of financial instrumentsvalued using significant unobservable inputs (Level 3) is presented as follows:

 

18

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| **(In thousands)**                       | ** ** | **Commodity Price  Swap Contracts** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------|------------|
| Balance at  December 31, 2007            |       | $                                             | —     |   |
| Gains included  in other comprehensive income |       | 3,118                                         |       |
| Balance at  March 31, 2008               |       | $                                             | 3,118      |   |

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Merger Agreement**

 

On March 18, 2007, ServiceMaster entered into the Merger Agreementwith Holdings and Acquisition Co. The Merger Agreement provided that, uponthe terms and subject to the conditions set forth in the Merger Agreement,Acquisition Co. would merge with and into ServiceMaster, withServiceMaster as the surviving corporation.

 

On the Closing Date, the Merger was completed, and each issued andoutstanding share of ServiceMaster common stock, other than shares held byServiceMaster or Holdings or their subsidiaries and shares held by stockholderswho validly perfected their appraisal rights under Delaware law, was convertedinto the right to receive $15.625 in cash. Each share of ServiceMaster commonstock owned by ServiceMaster, Holdings or Acquisition Co. or any of theirrespective direct or indirect wholly-owned subsidiaries was cancelled andretired, and no consideration was paid in exchange for it.

 

Immediately following the completion of the Merger, all of theoutstanding capital stock of Holdings, the ultimate parent company ofServiceMaster, was owned by investment funds sponsored by, or affiliates of theEquity Sponsors.

 

Equity contributions totaling $1,431 million from the EquitySponsors, together with (i) borrowings under a new $1,150 millionsenior unsecured interim loan facility (“Interim Loan Facility”), (ii) borrowingsunder a new $2,650 million senior secured term loan facility, and (iii) cashon hand at ServiceMaster, were used, among other things, to finance theaggregate Merger Consideration, to make payments in satisfaction of otherequity-based interests in ServiceMaster under the Merger Agreement, to settleexisting interest rate swaps, to redeem or provide for the repayment of certainof the Company’s existing indebtedness and to pay related transaction fees andexpenses. In addition, letters of credit issued under a new $150 millionpre-funded letter of credit facility (together with the senior secured termloan facility, the “Term Facilities”) were used to replace and/or secureletters of credit previously issued under a ServiceMaster credit facility thatwas terminated as of the Closing Date. On the Closing Date, the Company also enteredinto, but did not draw under, a new $500 million senior secured revolvingcredit facility (the “Revolving Credit Facility”).

 

In connection with the Merger and the related transactions (the “Transactions”),ServiceMaster retired certain of its existing indebtedness, includingServiceMaster’s $179.0 million, 7.875% notes due August 15, 2009 (the“2009 Notes”). On the Closing Date, the 2009 Notes were called for redemptionand they were redeemed on August 29, 2007. Additionally, the Companyutilized a portion of the proceeds from the Term Facilities to repay atmaturity ServiceMaster’s $49.2 million, 6.95% notes due August 15,2007.

 

**Results of Operations**

 

Although The ServiceMaster Company continued as the same legal entityafter the Merger, the accompanying consolidated financial statements arepresented for two periods, Predecessor and Successor, which relate to theperiod preceding the Merger and the period succeeding the Merger, 

 

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respectively.The separate presentation is required under GAAP when there is a change inaccounting basis, which occurred when purchase accounting was applied to theacquisition of the Predecessor. Purchase accounting requires that thehistorical carrying value of the assets acquired and liabilities assumed beadjusted to fair value, which may yield results that are not comparable on aperiod-to-period basis due to the different, and sometimes higher, cost basisassociated with the allocation of the purchase price. The Company refers to theoperations of The ServiceMaster Company for both the Predecessor and Successorperiods. The consolidated statement of financial position as of March 31,2008 and December 31, 2007 and the consolidated statements of operationsand of cash flows for the period  January 1,2008 to March 31, 2008 reflect the financial position, operations and cashflows of the Successor. The consolidated statements of operations and of cashflows for the period January 1, 2007 to March 31, 2007 reflect the operationsand cash flows of the Predecessor.

 

**First Quarter 2008 Compared to 2007**

 

The Company reported first quarter 2008 revenue of $632.2 million, a$41.3 million or 6.1 percent decrease compared to 2007. The revenue for thefirst quarter of 2008 has been reduced by $21.8 million (non-cash) resultingfrom recording deferred revenue at its fair value in connection with purchaseaccounting. Excluding this impact of purchase accounting, revenue for the firstquarter of 2008 decreased $19.5 million or 2.9 percent, from 2007 levels,driven by the results of our business units as described in our “SegmentReviews for the First Quarter 2008 Compared to 2007”.

 

Operating loss was $10.3 million in the first quarter of 2008 comparedto operating income of $25.1 million in 2007.  Loss from continuing operations before incometaxes was $106.1 million in the first quarter of 2008 compared to income fromcontinuing operations before income taxes of $16.8 million in 2007. The decreasein (loss) income from continuing operations before income taxes of $122.9million primarily reflects the net effect of:

 
| **(In  millions)**                            |   |   |   |
|-----------------------------------------------|--------|--------|--------|
| Non-cash  purchase accounting adjustments (1) |   | $      | (60.9  | ) |
| Increased  interest expense (2)               |   | (75.3  | )      |
| Decreased Merger  related charges (3)         |   | 2.5    |   |
| Decreased restructuring  charges (4)          |   | 3.7    |   |
| Improved segment  results (5)                 |   | 7.1    |   |
|                                          |   | $      | (122.9 | ) |

 

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(1)         The net unfavorable impactof non-cash purchase accounting adjustments in the first quarter of 2008 of$60.9 million consists primarily of increased amortization of intangible assetsof $48.3 million and a $21.8 million reduction in revenue partially offset byreduced deferred customer acquisition expense of $9.7 million.

 

(2)         Represents an increase ininterest expense as a result of the new debt structure entered into upon thecompletion of the Transactions.

 

(3)         Represents a decrease incharges related to the Merger which cannot be capitalized as part of thepurchase cost for financial reporting purposes.

 

(4)         Represents a decrease inrestructuring charges primarily resulting from the consolidation of the Company’scorporate headquarters into its operations support center in Memphis,Tennessee.

 

(5)         Represents an increase inincome from continuing operations before income taxes, non-cash purchaseaccounting adjustments, interest expense, merger related charges andrestructuring charges supported by the improved results at Terminix, TruGreen 

 

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LawnCare, TruGreen LandCare and Other Operations and Headquarters asdescribed in our “Segment Reviews for the First Quarter 2008 Compared to 2007”.

 

***Operating and Non-Operating Expenses***

 

The Company reported cost of services rendered and products sold of$417.4 million for the first quarter of 2008 compared to $443.4 million in2007. Excluding the unfavorable non-cash reduction of revenue of $21.8 millionresulting from recording deferred revenue at its fair value in conjunction withpurchase accounting, as a percentage of revenue these costs decreased to 63.8percent for the first quarter of 2008 from 65.8 percent in 2007. Thisdecrease primarily reflects the impact of improved labor efficiency at Terminixand a decrease in the incidence of contract claims at AHS, offset by increasesin fuel and other factor costs throughout the enterprise.

 

The Company reported selling and administrative expenses of $171.1million for the first quarter of 2008 compared to $193.2 million in 2007.The first quarter of 2008 includes a $9.7 million (non-cash) decrease inselling and administrative expenses resulting from recording deferred customeracquisition costs at their fair value in connection with purchase accounting.Excluding this impact of purchase accounting, these costs decreased as apercentage of revenue to 27.6 percent for the first quarter of 2008 from28.7 percent for 2007. The decrease in selling and administrative expensesas a percentage of revenue primarily reflects lower functional support costsand improved sales labor efficiency at TruGreen LawnCare and Terminix and lowercompensation charges for the Company resulting from a decrease in the marketvalue of investments within an employee deferred compensation trust (for whichthere is a corresponding and offsetting decrease within interest and netinvestment loss (income)).

 

Amortization expense was $50.7 million for the first quarter of 2008compared to $2.3 million for 2007. The increase reflects$48.3 million of amortization for the first quarter of 2008 related torecording amortizable intangible assets of $844 million in purchaseaccounting.

 

Non-operating expense totaled $95.8 million for the first quarterof 2008 compared with $8.2 million for 2007. This change includes a$75.3 million increase in interest expense for the first quarter of 2008,primarily resulting from the increased debt levels related to the Merger, and a$14.1 million decrease in interest and investment income for the first quarterof 2008 primarily reflecting (1) the unfavorable  impact to investment gains and incomerealized on the American Home Shield investment portfolio of $11.6 million, dueto other than temporary declines in the value of certain investments and (2) lowerinvestment income resulting from a decrease in the market value of investmentswithin an employee deferred compensation trust of $3.2 million (for which thereis a corresponding and offsetting decrease in compensation expense withinoperating loss (income)).

 

The effective tax rate on (loss) income from continuing operations wasa benefit of 29.2 percent for the first quarter of 2008 compared to an expenseof 40.2 percent for 2007. The change in the effective tax rate is primarily dueto state tax expense offsetting the statutory federal benefit generated due tolosses in 2008 as a result of the Merger compared to state tax expense increasingthe effective tax rate in 2007.

 

***Restructuring and Merger RelatedCharges***

 

TheCompany is engaged in a reorganization and restructuring of certain of itsbusinesses and support functions under Fast Forward. Among the purposes of FastForward is to eliminate layers and bureaucracy and simplify work processes inorder to better align the Company’s work processes around its operational andstrategic objectives. It is expected that Fast Forward will be effected inphases. The first phase involves, among other things, a reduction in work forceand various process improvements, including the closing of American Home Shield’scall center located in Santa Rosa, California. The second phase is expected toinclude the organization of certain corporate support functions into Centers ofExcellence (“COE”s) which are expected to deliver higher quality services toour business units at lower costs, the outsourcing to third party vendors ofvarious business activities that currently are handled internally, as well as otheremployee workforce reductions expected to result in cost-savings. The first 

 

21

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phaseof Fast Forward was substantially completed in the first quarter of 2008, andthe second phase is expected to begin implementation in the second half of2008.

 

Inconnection with Fast Forward, the Company incurred costs in the three monthsended March 31, 2008 of approximately $2.6 million. Such costsinclude consulting fees of approximately $1.6 million and severance andother costs of approximately $1.0 million. No costs related to FastForward were incurred in the three months ended March 31, 2007.

 

TheCompany expects that it will incur substantial additional costs in order toimplement the second phase of Fast Forward, but is currently unable to estimatethe aggregate amount or timing of such charges or the anticipated related cashoutlays.

 

Management has set a goal of achieving $60 million in annual costsavings from Fast Forward and other initiatives currently underway, which areexpected to be fully realized by the end of 2009.

 

The 2007 first quarterresults include restructuring charges related to the Company’s consolidation ofits corporate headquarters into its operations support center in Memphis,Tennessee and the closing of its headquarters in Downers Grove, Illinois.  The transition to Memphiswas substantially completed in 2007. Almost all costs related to the transition were cash expenditures, and,in accordance with GAAP, these costs were expensed throughout the transitionperiod.  In the three months ended March 31,2007, the Company recognized charges of approximately $7.1 million.  These charges consisted of $6.1 million ofemployee retention and severance and $1.0 million of recruiting and related costs.

 

Duringthe three months ended March 31, 2008, the Company incurred an additional$0.7 million relating to this relocation, which includes additional severanceand other costs.

 

**Key Performance Indicators**

 

The table below presents selected operating metrics related to customercounts and customer retention for the three largest profit businesses in theCompany. These measures are presented on a rolling, twelve-month basis in orderto avoid seasonal anomalies.

 
| ** **                            | ** ** | **Key  Performance  Indicators  as of March 31,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                                         | ** ** | **2007** | ** ** |
| **TruGreen  LawnCare—**          |       |                                                             |       |   |   |
| Growth in Full  Program Accounts      |       | -2                                                               | %          | 1 | % |
| Customer  Retention Rate              |       | 67.1                                                             | %          | 66.8 | % |
| **Terminix(a)—**                 |       |                                                             |       |   |   |
| Growth in Pest  Control Customers     |       | 1                                                                | %          | 8 | % |
| Pest Control  Customer Retention Rate |       | 77.9                                                             | %          | 78.7 | % |
| Growth in  Termite Customers          |       | 2                                                                | %          | 0 | % |
| Termite Customer  Retention Rate      |       | 87.8                                                             | %          | 87.5 | % |
| **American  Home Shield—**       |       |                                                             |       |   |   |
| Growth in  Warranty Contracts         |       | 4                                                                | %          | 3 | % |
| Customer  Retention Rate              |       | 62.0                                                             | %          | 58.7 | % |

 

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(a)                                 Pest controlcustomer count growth as of March 31, 2007, excluding the impact of theSafeguard Pest Control (“SafeGuard”) acquisition completed at the beginning ofthe fourth quarter of 2006, was 5%. This acquisition had no impact on thecustomer retention rate as of March 31, 2007.

 

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**Segment Reviews for the First Quarter 2008 Compared to2007**

 

The following business segment reviews should be read in conjunctionwith the required footnote disclosures presented in the Notes to the CondensedConsolidated Financial Statements. This disclosure provides a reconciliation ofsegment operating (loss) income to (loss) income from continuing operationsbefore income taxes, with net non-operating expenses as the only reconcilingitem.

 

The Company uses Adjusted EBITDA and Comparable Operating Performanceto facilitate operating performance comparisons from period to period. AdjustedEBITDA and Comparable Operating Performance are supplemental measures of theCompany’s performance that are not required by, or presented in accordancewith, GAAP. Adjusted EBITDA and Comparable Operating Performance are notmeasurements of the Company’s financial performance under GAAP and should notbe considered as alternatives to net income or any other performance measuresderived in accordance with GAAP or as alternatives to net cash provided byoperating activities or any other measures of the Company’s cash flow orliquidity. “Adjusted EBITDA” means net income before net income (loss) frombusinesses held pending sale and discontinued operations; provision (benefit)for income taxes; minority interest and other expense, net; interest expenseand interest and net investment income; and depreciation and amortizationexpense; as well as adding back interest and net investment income. The Companyviews its total interest and investment income as an integral part of itsbusiness model and earnings stream. “Comparable Operating Performance” iscalculated by adding back to Adjusted EBITDA non-cash option and restrictedstock expense and non-cash effects on Adjusted EBITDA attributable to theapplication of purchase accounting in connection with the Merger.

 

The Company believes Adjusted EBITDA facilitates company-to-companyoperating performance comparisons by backing out potential differences causedby variations in capital structures (affecting net interest income andexpense), taxation and the age and book depreciation of facilities andequipment (affecting relative depreciation expense), which may vary fordifferent companies for reasons unrelated to operating performance. The Companyuses Comparable Operating Performance as a supplemental measure to assess theCompany’s performance because it excludes non-cash option and restricted stockexpense and non-cash effects on Adjusted EBITDA attributable to the applicationof purchase accounting in connection with the Merger. The Company presentsComparable Operating Performance because it believes that it is useful forinvestors and lenders to analyze disclosures of the Company’s operating resultson the same basis as that used by the Company’s management.

 

Adjusted EBITDA and Comparable Operating Performance are notnecessarily comparable to other similarly titled financial measures of othercompanies due to the potential inconsistencies in the method of calculation.

 

Adjusted EBITDA and Comparable Operating Performance have limitationsas analytical tools, and should not be considered in isolation or assubstitutes for analyzing the Company’s results as reported under GAAP. Some ofthese limitations are:

 

·                  Adjusted EBITDA and ComparableOperating Performance do not reflect changes in, or cash requirements for, theCompany’s working capital needs;

 

·                  Adjusted EBITDA andComparable Operating Performance do not reflect the Company’s interest expense,or the cash requirements necessary to service interest or principal payments onthe Company’s debt;

 

·                  Adjusted EBITDA andComparable Operating Performance do not reflect the Company’s tax expense orthe cash requirements to pay the Company’s taxes;

 

·                  Adjusted EBITDA andComparable Operating Performance do not reflect historical cash expenditures orfuture requirements for capital expenditures or contractual commitments;

 

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·                Although depreciation and amortization arenon-cash charges, the assets being depreciated and amortized will often have tobe replaced in the future, and Adjusted EBITDA and Comparable OperatingPerformance do not reflect any cash requirements for such replacements; and

 

·                Other companies in the Company’s industriesmay calculate Adjusted EBITDA and Comparable Operating Performance differently,limiting their usefulness as comparative measures.

 

Operating revenues and Comparable Operating Performance by operatingsegment are as follows:

 
| ** **                                                                                     | ** ** | **Successor**                | ** ** | **Predecessor**              | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                                     | ** ** | **Three**                    | ** ** | **Three**                    | ** ** |
| ** **                                                                                     | ** ** | **Months Ended**        | ** ** | **Months Ended**        | ** ** |
| **(In thousands)**                                                                        | ** ** | **March 31, 2008** | ** ** | **March 31, 2007** | ** ** |
| Operating  Revenue:                                                                            |       |                         |       |                         |       |
| TruGreen  LawnCare                                                                             |       | $                            | 134,442    |                         | $          | 132,672 |   |
| TruGreen  LandCare                                                                             |       | 78,652                       |       | 102,942                      |       |
| Terminix                                                                                       |       | 261,648                      |       | 262,172                      |       |
| American Home Shield                                                                           |       | 105,418                      |       | 125,187                      |       |
| Other Operations  and Headquarters                                                             |       | 52,071                       |       | 50,522                       |       |
| Total Operating  Revenue                                                                       |       | $                            | 632,231    |                         | $          | 673,495 |   |
| Comparable  Operating Performance:                                                             |       |                         |       |                         |       |
| TruGreen  LawnCare                                                                             |       | $                            | (6,737     | )                            | $          | (7,753 | ) |
| TruGreen  LandCare                                                                             |       | 4,697                        |       | 1,484                        |       |
| Terminix                                                                                       |       | 55,499                       |       | 49,343                       |       |
| American Home  Shield                                                                          |       | 5,784                        |       | 15,711                       |       |
| Other Operations  and Headquarters                                                             |       | 1,932                        |       | (9,806                       | )          |
| Total Comparable  Operating Performance                                                        |       | $                            | 61,175     |                         | $          | 48,979 |   |
|                                                                                           |       |                         |       |                         |       |
| Memo: Items  included in Comparable Operating Performance                                      |       |                         |       |                         |       |
| Restructuring  charges and Merger related expenses(1)                                          |       | $                            | 3,375      |                         | $          | 9,598 |   |
| Management  fee(2)                                                                             |       | $                            | 500        |                         | $          | — |   |
|                                                                                           |       |                         |       |                         |       |
| Memo: Items  excluded from Comparable Operating Performance                                    |       |                         |       |                         |       |
| Comparable  Operating Performance of InStar                                                    |       | $                            | (976       | )                            | $          | (1,313 | ) |
| Comparable  Operating Performance of all other discontinued operations                         |       | (161                         | )          | (126                         | )          |
| Comparable  Operating Performance of businesses held pending sale and discontinued  operations |       | $                            | (1,137     | )                            | $          | (1,439 | ) |

 

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(1)                               ComparableOperating Performance includes (i)  severance costs and costs relatedto the consolidation of our corporate headquarters in Memphis, Tennessee,including the closing of our office in Downers Grove, Illinois, (ii) coststo exit leases and severance payments related to organizational changes withinthe TruGreen LandCare operations, (iii) charges related to Fast 

 

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Forward and (iv) Merger related expenses. Substantially all of therestructuring charges and Merger related expenses are included in the ComparableOperating Performance of the Other Operations and Headquarters segment.

 

(2)                               Represents amanagement fee payable to CD&R pursuant to a consulting agreement underwhich CD&R will provide the Company with on-going consulting and managementadvisory services for a minimum annual fee of $2 million.

 

The following table presents reconciliations of operating (loss)income, the most directly comparable financial measure under GAAP, to AdjustedEBITDA and Comparable Operating Performance for the periods presented.

 
| **(In thousands)**                                                                        | ** ** | **TruGreen  LawnCare** | ** ** | **TruGreen  LandCare** | ** ** | **Terminix** | ** ** | **American  Home Shield** | ** ** | **Other  Operations  and  Headquarters** | ** ** | **Total**  | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|--------------|------------|--------------------------------|------------|------------------------------------------|------------|------------|------------|
| ** **                                                                                     | ** ** | ** **             | ** ** | ** **             | ** ** | ** **   | ** ** | ** **                     | ** ** | ** **                               | ** ** | ** ** | ** ** |
| **Successor  Three Months Ended March 31, 2008**                                          | ** ** | ** **             | ** ** | ** **             | ** ** | ** **   | ** ** | ** **                     | ** ** | ** **                               | ** ** | ** ** | ** ** |
| Operating (loss)  income (1)                                                                   |       | $                      | (34,059    | )                      | $          | 2,091        |       | $                              | 43,213     |                                     | $          | (17,692    | )          | $ | (3,855 | ) | $ | (10,302 | ) |
| Depreciation and  amortization expense                                                         |       | 27,309                 |       | 2,769                  |       | 15,012       |       | 12,683                         |       | 5,459                                    |       | 63,232     |       |
| EBITDA before  adding back interest and investment income, net                                 |       | (6,750                 | )          | 4,860                  |       | 58,225       |       | (5,009                         | )          | 1,604                                    |       | 52,930     |       |
| Interest and  investment income, net(2)                                                        |       | —                 |       | —                 |       | —       |       | (4,501                         | )          | (1,544                                   | )          | (6,045     | )          |
| Adjusted EBITDA                                                                                |       | (6,750                 | )          | 4,860                  |       | 58,225       |       | (9,510                         | )          | 60                                       |       | 46,885     |       |
| Non-cash option  and restricted stock expense                                                  |       | —                 |       | —                 |       | —       |       | —                         |       | 1,664                                    |       | 1,664      |       |
| Non-cash charges  attributable to purchase accounting(3)                                       |       | 13                     |       | (163                   | )          | (2,726       | )          | 15,294                         |       | 208                                      |       | 12,626     |       |
| Comparable  Operating Performance                                                              |       | $                      | (6,737     | )                      | $          | 4,697        |       | $                              | 55,499     |                                     | $          | 5,784      |       | $ | 1,932 |   | $ | 61,175 |   |
|                                                                                           |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Memo: Items  included in Comparable Operating Performance                                      |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Restructuring  charges and merger related expenses(4)                                          |       | $                      | 281        |                   | $          | (421         | )          | $                              | 57         |                                     | $          | —     |       | $ | 3,458 |   | $ | 3,375 |   |
| Management  fee(5)                                                                             |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | 500 |   | $ | 500 |   |
|                                                                                           |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Memo: Items  excluded from Comparable Operating Performance                                    |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Comparable  Operating Performance of InStar                                                    |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | (976 | ) | $ | (976 | ) |
| Comparable  Operating Performance of all other discontinued operations                         |       | —                 |       | —                 |       | —       |       | —                         |       | (161                                     | )          | (161       | )          |
| Comparable  Operating Performance of businesses held pending sale and discontinued  operations |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | (1,137 | ) | $ | (1,137 | ) |
|                                                                                           |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| **Predecessor  Three Months Ended March 31, 2007**                                        | ** ** | ** **             | ** ** | ** **             | ** ** | ** **   | ** ** | ** **                     | ** ** | ** **                               | ** ** | ** ** | ** ** |
| Operating (loss)  income (1)                                                                   |       | $                      | (11,593    | )                      | $          | 66           |       | $                              | 44,771     |                                     | $          | 7,021      |       | $ | (15,203 | ) | $ | 25,062 |   |
| Depreciation and  amortization expense                                                         |       | 3,840                  |       | 1,418                  |       | 4,572        |       | 1,628                          |       | 2,838                                    |       | 14,296     |       |
| EBITDA before  adding back interest and investment income, net                                 |       | (7,753                 | )          | 1,484                  |       | 49,343       |       | 8,649                          |       | (12,365                                  | )          | 39,358     |       |
| Interest and  investment income, net(2)                                                        |       | —                 |       | —                 |       | —       |       | 7,062                          |       | 1,004                                    |       | 8,066      |       |
| Adjusted EBITDA                                                                                |       | (7,753                 | )          | 1,484                  |       | 49,343       |       | 15,711                         |       | (11,361                                  | )          | 47,424     |       |
| Non-cash option  and restricted stock expense                                                  |       | —                 |       | —                 |       | —       |       | —                         |       | 1,555                                    |       | 1,555      |       |
| Non-cash charges  attributable to purchase accounting(3)                                       |       | —                 |       | —                 |       | —       |       | —                         |       | —                                   |       | —     |       |
| Comparable  Operating Performance                                                              |       | $                      | (7,753     | )                      | $          | 1,484        |       | $                              | 49,343     |                                     | $          | 15,711     |       | $ | (9,806 | ) | $ | 48,979 |   |
| Memo: Items  included in Comparable Operating Performance                                      |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Restructuring  charges and merger related expenses(4)                                          |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | 9,598 |   | $ | 9,598 |   |
| Management  fee(5)                                                                             |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | — |   | $ | — |   |
|                                                                                           |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Memo: Items  excluded from Comparable Operating Performance                                    |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Comparable  Operating Performance of InStar                                                    |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | (1,313 | ) | $ | (1,313 | ) |
| Comparable  Operating Performance of all other discontinued operations                         |       | —                 |       | —                 |       | —       |       | —                         |       | (126                                     | )          | (126       | )          |
| Comparable  Operating Performance of businesses held pending sale and discontinued  operations |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | (1,439 | ) | $ | (1,439 | ) |

 

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(1)                                 Presented belowis a reconciliation of segment operating (loss) income to net (loss) income.

 
| ** **                                                                               | ** ** | **Successor**                | ** ** | **Predecessor**              | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                               | ** ** | **Three**                    | ** ** | **Three**                    | ** ** |
| ** **                                                                               | ** ** | **Months Ended**        | ** ** | **Months Ended**        | ** ** |
| **(In thousands)**                                                                  | ** ** | **March 31, 2008** | ** ** | **March 31, 2007** | ** ** |
| Segment  Operating (Loss) Income                                                         |       | $                            | (10,302    | )                            | $          | 25,062 |   |
| Non-operating  expense (income):                                                         |       |                         |       |                         |       |
| Interest expense                                                                         |       | 89,586                       |       | 14,264                       |       |
| Interest and net  investment loss (income)                                               |       | 6,045                        |       | (8,066                       | )          |
| Minority interest  and other expense, net                                                |       | 132                          |       | 2,049                        |       |
| (Loss) Income  from Continuing Operations before Income Taxes                            |       | $                            | (106,065   | )                            | $          | 16,815 |   |
| (Benefit)  Provision for income taxes                                                    |       | (30,971                      | )          | 6,767                        |       |
| (Loss) Income  from Continuing Operations                                                |       | $                            | (75,094    | )                            | $          | 10,048 |   |
| Loss from  businesses held pending sale and discontinued operations, net of income taxes |       | (748                         | )          | (1,499                       | )          |
| Net (Loss)  Income                                                                       |       | $                            | (75,842    | )                            | $          | 8,549 |   |

 

(2)                               Interest andinvestment income is primarily comprised of investment income and realizedgains/losses on our American Home Shield (“AHS”) segment investment portfolio.Cash, short-term and long-term marketable securities associated with regulatoryrequirements in connection with AHS and for other purposes totaledapproximately $353 million as of March 31, 2008. AHS interest andinvestment (loss) income was ($5) million for the first quarter of 2008and $7 million for the first quarter of 2007. The balance of interest andinvestment income primarily relates to (i) a portion of the earningsgenerated by ServiceMaster Acceptance Company Limited Partnership, ourfinancing subsidiary exclusively dedicated to providing financing to ourfranchisees and retail customers of our operating units; (ii) investmentincome from our employee deferred compensation trust (for which there is acorresponding and offsetting increase in compensation expense within operatingincome); and (iii) interest income on other cash balances.

 

(3)                               The Merger wasaccounted for using purchase accounting. This adjustment represents theaggregate, non-cash adjustments (other than amortization and depreciation)attributable to the application of purchase accounting.

 

(4)                               Includes (i) severancecosts and costs related to the consolidation of our corporate headquarters inMemphis, Tennessee, including the closing of our office in Downers Grove,Illinois, (ii) costs to exit leases and severance payments related toorganizational changes within the TruGreen LandCare operations, (iii) Mergerrelated expenses and (iv) charges related to Fast Forward.

 

(5)                               The Companyentered into a consulting agreement with CD&R under which CD&R willprovide the Company with on-going consulting and management advisory servicesin exchange for a minimum annual management fee of $2 million. This fee ispayable quarterly.

 

***TruGreen LawnCare Segment***

 

The TruGreen LawnCare segment, which includes lawn, tree and shrub careservices, reported a 1.3 percent increase in revenue, a 193.8 percent decreasein operating income and a 13.1 percent increase in Comparable OperatingPerformance for the first quarter of 2008 compared to 2007. The increase inrevenue resulted from additional seasonal sales of ice-melt materials andimproved price realization. Customer counts at March 31, 2008 were2.2 percent lower than last year’s level. Improved customer retentionhelped offset an 11.8 percent decline in new sales, which were adverselyimpacted by poor weather. The rolling twelve-month retention rate improved30 basis points over last year, driven by improvements in overall quality ofservice delivery and enhanced customer communication, including the LawnQuality Audit (“LQA”) visits initiated during the second half of 2006. TheCompany is seeking to improve customer retention over the next several years asit expands the LQA program, focuses its efforts on reducing route managerturnover and continues to improve overall communication with customers.

 

The 13.1 percent increase in Comparable Operating Performance for thefirst quarter of 2008 compared to 2007 also reflects reduced overhead spendingoffset, in part, by increased fuel costs.

 

***TruGreen LandCare Segment***

 

The TruGreen LandCare segment, which includes landscape maintenanceservices, reported a 23.6 percent decrease in revenue, a 3,068.2 percentincrease in operating income and a 216.5 percent increase in ComparableOperating Performance for the first quarter of 2008 compared to 2007. Thedecline in revenue included a 19.6 percent decline in base contract maintenancerevenue, a 15.8 percent 

 

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decreasein enhancement revenue, and a $7.8 million decrease in snow removalservice revenue. The revenue comparison was adversely impacted by branchclosures completed during the third quarter of 2007, as well as the impacts ofthe Company’s efforts to improve the quality of its customer base with a bettercustomer mix by pruning less profitable jobs, implementing stricter pricing onnew sales, and increasing the average size of new proposals and sales. Althoughthe total base contract maintenance sales dollars declined for the firstquarter of 2008, the Company realized a meaningful improvement in the averagevalue per contract sold (higher value contracts tend to be more profitable).

 

TruGreen LandCare’s Comparable Operating Performance includes the impactof the reversal of $0.4 million of restructuring charges in the first quarterof 2008. Excluding the impact of the restructuring charges Comparable OperatingPerformance improved 188.1 percent for the first quarter of 2008 compared to2007, primarily due to a favorable shift of revenue mix towards higher marginenhancement revenue and improved materials and labor management on the basecontract maintenance portfolio. These factors were offset, in part, byincreased fuel costs.

 

Over the next several years, the Company’s plan targets marginimprovement, which the Company believes can be accomplished through: (1) abetter customer mix, reflecting higher average job size, stricter pricing onnew sales, and the pruning of less profitable jobs, (2) improvement inbranch manager selection and training, and (3) increased customerretention from new operating and account management initiatives.

 

***Terminix Segment***

 

The Terminix segment, which includes termite and pest control services,reported a 0.2 percent decrease in revenue for the first quarter of 2008compared to 2007. Revenue for the first quarter of 2008 has been reduced by$2.1 million (non-cash) as a result of recording deferred revenue at its fairvalue in connection with purchase accounting. Excluding this impact of purchaseaccounting, revenue increased 0.6 percent for the first quarter of 2008compared to 2007. Terminix reported a 3.5 percent decrease in operatingincome and a 12.5 percent increase in Comparable Operating Performance forthe first quarter of 2008 compared to 2007. The segment’s overall revenuegrowth, excluding purchase accounting, reflected modest growth in pest controlrevenues and increases in termite contract renewals, offset, in part, by a 6.4percent decline in revenue from termite completions. Pest control revenuesincreased 3.3 percent for the first quarter of 2008 as compared to 2007, as theimpact of acquisitions more than offset a decrease in new unit sales. A 1.4percent increase in renewal revenues for the first quarter of 2008 wassupported by improved pricing and a 30 basis point improvement in termitecustomer retention.

 

Revenue from termite completions declined 6.4 percent for the firstquarter of 2008, as termite swarm activity was negatively impacted by coolerthan normal weather conditions. However, renewable unit sales were flat with2007 levels, driven by the Company’s new Termite Inspection and Protection Planoffering. The revenue related to Termite Inspection and Protection Plan salesis deferred and recognized over the one year term of the contract. The growthin Comparable Operating Performance also reflects lower termite materialscosts, effective management of seasonal staffing of production and sales labor,and reduced overhead spending, offset, in part, by increased fuel costs.

 

***American Home Shield Segment***

 

The American Home Shield segment, which provides home warranties toconsumers that cover heating, ventilation, air conditioning, plumbing and othersystems and appliances, reported a 15.8 percent decrease in revenue for thefirst quarter of 2008 compared to 2007. Revenue for the first quarter of 2008has been reduced by $19.6 million (non-cash) as a result of recording deferredrevenue at its fair value in connection with purchase accounting. Excluding thisimpact of purchase accounting, revenue decreased 0.1 percent for the firstquarter of 2008 over the first quarter of 2007. American Home Shield reported a352.0 percent decrease in operating income and a 63.2 percentdecrease in Comparable Operating Performance for the first quarter of 2008 overthe first quarter of 2007. New contract sales and renewal units, which arereported as earned revenue over the subsequent twelve-month contract period,decreased 

 

27

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2.9 percent.Contract unit sales from customer renewals increased 6.2 percent, reflecting alarger base of renewable customers and a 330 basis point improvement inretention. American Home Shield’s sales in the real estate channel weresignificantly impacted by the continued softness in the home resale marketthroughout most of the country with overall unit sales declines of 23.9 percentthrough this channel. Real estate unit sales, excluding the impact of salesgenerated through an agreement with Realogy Corporation, declined 28.7 percent.The Company expects incremental sales in 2008 generated through its agreementwith Realogy Corporation to partially offset the impact of continued softnessin the home resale market throughout most of the country. The decrease inComparable Operating Performance for the first quarter of 2008 also includes an$11.6 million decrease in interest and investment income from the AmericanHome Shield investment portfolio (primarily reflecting the unfavorable impactto investment gains and income due to other than temporary declines in thevalue of certain investments) as compared to 2007 partially offset by adecrease in the incidence of contract claims from the levels experienced lastyear and the beneficial impacts of increases in prices and service fees perclaim.

 

***Other Operations and HeadquartersSegment***

 

This segment includes the operations of ServiceMaster Clean and MerryMaids, as well as the Company’s headquarters functions. The segment reported a3.1 percent increase in revenue for the first quarter of 2008 compared to 2007.The ServiceMaster Clean and Merry Maids operations reported a combined 3.6percent increase for the first quarter of 2008. The growth in revenue resultedfrom strong increases in disaster restoration services, offset by decreases inproduct sales. The ServiceMaster Clean and Merry Maids operations reported acombined decrease in operating income of 12.6 percent and an increase inComparable Operating Performance of 9.2 percent for first quarter of 2008compared to 2007. The increase in the segment’s Comparable OperatingPerformance for the first quarter of 2008 compared to 2007 primarily reflectsthe decrease in Restructuring and Merger related expenses incurred in 2008,increased Comparable Operating Performance from the ServiceMaster Clean andMerry Maids operations, lower functional support costs and lower compensationcharges resulting from a decrease in the market value of investments within anemployee deferred compensation trust (for which there is a corresponding andoffsetting decrease within interest and net investment income).

 

***Discontinued Operations***

 

The components of loss from businesses held pending sale anddiscontinued operations, net of income taxes, and the reconciliation ofoperating (loss) income to Adjusted EBITDA and Comparable Operating Performancefor the three months ended March 31, 2008 and March 31, 2007 are asfollows:

 
| ** **                                                                               | ** ** | **Successor**                | ** ** | **Predecessor**              | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                               | ** ** | **Three**                    | ** ** | **Three**                    | ** ** |
| ** **                                                                               | ** ** | **months ended**        | ** ** | **months ended**        | ** ** |
| **(In thousands)**                                                                  | ** ** | **March 31, 2008** | ** ** | **March 31, 2007** | ** ** |
| Operating loss                                                                           |       | $                            | (1,137     | )                            | $          | (2,473 | ) |
| Interest expense                                                                         |       | (41                          | )          | (19                          | )          |
| Pretax loss                                                                              |       | (1,178                       | )          | (2,492                       | )          |
| Benefit from  income taxes                                                               |       | (430                         | )          | (993                         | )          |
| Loss from  businesses held pending sale and discontinued operations, net of income taxes |       | $                            | (748       | )                            | $          | (1,499 | ) |
|                                                                                     |       |                         |       |                         |       |
| Operating loss                                                                           |       | $                            | (1,137     | )                            | $          | (2,473 | ) |
| Depreciation and  amortization expense                                                   |       | —                       |       | 1,034                        |       |
| EBITDA before  adding back interest and investment income, net                           |       | (1,137                       | )          | (1,439                       | )          |
| Interest and  investment income, net                                                     |       | —                       |       | —                       |       |
| Adjusted EBITDA                                                                          |       | (1,137                       | )          | (1,439                       | )          |
| Non-cash option  and restricted stock expense                                            |       | —                       |       | —                       |       |
| Non-cash charges  attributable to purchase accounting                                    |       | —                       |       | —                       |       |
| Comparable  Operating Performance                                                        |       | $                            | (1,137     | )                            | $          | (1,439 | ) |

 

28

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**FINANCIAL POSITION AND LIQUIDITY**

 

***Cash Flows from Operating Activities fromContinuing Operations***

 

Netcash used in operating activities from continuing operations was $65.5 millionin the first quarter of 2008 compared to $36.1 million in 2007.

 

Theprincipal components (in millions) of the net decrease for the firstquarter of 2008 were:

 
| Decrease in net  income before merger related charges, restructuring charges and non-cash  charges |   | (33.7 | )      |
|----------------------------------------------------------------------------------------------------|--------|-------|--------|
| Increase in  restructuring payments                                                                |   | (11.3 | )      |
| Decrease in working  capital requirements                                                          |   | 15.6  |   |
|                                                                                               |   | (29.4 | )      |

 

Thedecrease in net income before merger related charges, restructuring charges andnon-cash charges for the first quarter of 2008 was driven by increased interestpayments offset by Comparable Operating Performance growth at Terminix,TruGreen LawnCare, TruGreen LandCare and Other Operations and Headquarters. Thedecrease in working capital requirements for the first quarter of 2008 wasdriven primarily by increased customer prepayments and accounts receivable collectionsand growth in interest accruals offset by increased tax assets reflecting theimpact of future tax deductions related to the Company’s net operating losscarryforwards generated in 2008.

 

*Historically, the first quarter is a period of investmentfor many of the Company’s businesses as they prepare for the summer and fallproduction season.  This patterncontinued in both the 2008 and 2007 first quarters.*

* *

***Cash Flows from Investing Activities fromContinuing Operations***

 

Netcash used for investing activities from continuing operations was $14.5 millionin the first quarter of 2008. Net cash used for investing activities for thefirst quarter of 2008 included $16.2 million paid in connection with theMerger, primarily related to payments under change in control agreements.

 

Capitalexpenditures decreased to $9.0 million for the first quarter of 2008 from $12.2million in the prior year and included recurring capital needs and informationtechnology projects. The Company anticipates that capital expenditures for theremainder of 2008 will total approximately $36 million to$46 million, reflecting the continuation of investments in informationsystems and productivity enhancing operating systems. In addition, as furtherdiscussed hereunder in “Liquidity”, the Company expects to pay approximately$50 million to acquire assets in connection with exiting certain of itsfleet leases. The Company has no additional material capital commitments atthis time.

 

Acquisitionsfor the first quarter of 2008 totaled $4.4 million, compared with $13.3 millionin 2007. Consideration paid for tuck-in acquisitions consisted of cash paymentsand seller financed debt. The Company expects to continue its tuck-inacquisition program at both Terminix and TruGreen LawnCare.

 

Thechange in notes receivable, financial investments and securities for the firstquarter of 2008 includes an increase in the net sale of marketable securitiesat American Home Shield due in part to lowering the amount of excess reservesover minimum statutory reserve requirements in certain states in accordancewith our investment policy and reduced statutory reserve requirements.

 

***Cash Flows from Financing Activities fromContinuing Operations***

 

Duringthe first quarter of 2008 the Company made net borrowings of $45.0 millionunder our Revolving Credit Facility.  The borrowings reflect normalseasonal working capital needs.  The Company also made 

 

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scheduledprincipal payments of long-term debt of $21.4 million in the first quarter of2008.  Borrowings and payments of debt during the first quarter of 2007were primarily related to the funding of seasonal working capital needs throughthe Company’s revolving bank credit facility.  Cash dividends paid to shareholderstotaled $35.0 million for the first quarter of 2007.  No dividends werepaid to the Company’s shareholder in the first quarter of 2008.  Duringthe first quarter of 2007, the Company received proceeds of $26.5 million underan employee share purchase plan.  The employee share purchase plan wasterminated subsequent to the Merger.

 

***Liquidity***

 

TheMerger was completed on the Closing Date. Following the completion of theMerger, the Company is highly leveraged, and a very substantial portion of the Company’sliquidity needs arise from debt service on indebtedness incurred in connectionwith the Merger and from funding the Company’s operations, working capital andcapital expenditures. Equity contributions totaling $1,431 million fromthe Equity Sponsors, together with (i) borrowings under the $1,150 millionInterim Loan Facility, (ii) borrowings under a new $2,650 millionsenior secured term loan facility, and (iii) cash on hand atServiceMaster, were used, among other things, to finance the aggregate MergerConsideration, to make payments in satisfaction of other equity-based interestsin ServiceMaster under the Merger Agreement, to settle existing interest rateswaps, to redeem or provide for the repayment of certain of the Company’sexisting indebtedness and to pay related transaction fees and expenses. Inaddition, letters of credit issued under a new $150 million pre-fundedletter of credit facility were used to replace and/or secure letters of creditpreviously issued under a ServiceMaster credit facility that was terminated asof the Closing Date. On the Closing Date, the Company also entered into, butdid not draw under, the $500 million Revolving Credit Facility.

 

Theagreements governing the Term Facilities, the Interim Loan Facility and the RevolvingCredit Facility contain certain covenants that limit or restrict the incurrenceof additional indebtedness, liens, sales of assets, certain payments (includingdividends) and transactions with affiliates, subject to certain exceptions. TheCompany was in compliance with the covenants under these agreements at March 31,2008.

 

TheInterim Loan Facility will mature on July 24, 2008. On the maturity date(or at the election of the Company following the completion of a standard highyield road show after which no senior notes to refinance in whole or part theInterim Loan Facility loans were issued) outstanding amounts under the InterimLoan Facility shall be converted into 10.75%/11.50% senior toggle notes due2015 (“Permanent Notes”). The Permanent Notes would be issued pursuant to arefinancing indenture. In connection with the issuance of Permanent Notes,ServiceMaster would enter into a registration rights agreement to be dated thedate of the issuance of the Permanent Notes, pursuant to which ServiceMasterwill be required to file a shelf registration statement (or, at ServiceMaster’soption, an exchange offer registration statement) with respect to the PermanentNotes.

 

TheCompany may, at its option prior to the start of any interest period, elect topay interest on outstanding amounts under the Interim Loan Facility orPermanent Notes through July 2011 entirely in cash (“Cash Interest”),entirely by increasing the principal amount of the outstanding loans (“PIKInterest”), or 50% as Cash Interest and 50% as PIK Interest. It is the Company’sintent to elect to pay Cash Interest in 2008.

 

Cashand short- and long-term marketable securities totaled approximately$392 million at March 31, 2008, compared with approximately$469 million at December 31, 2007. Approximately $353 million of thecash and short- and long-term marketable securities balance as of March 31,2008 is associated with regulatory requirements at American Home Shield and forother purposes. For example, the payment of ordinary and extraordinarydividends to ServiceMaster by our subsidiaries that are regulated as insurance,home warranty or similar companies is subject to applicable state lawlimitations. AHS’ investment portfolio has been invested in a combination ofhigh quality, short duration fixed income securities and equities. The Companyclosely monitors the performance of the investments.

 

30

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TheCompany has an arrangement enabling it to sell, on a revolving basis andwithout recourse, certain receivables generated by our TruGreen LawnCare andTerminix segments to unrelated third party purchasers. The Company may sell upto $70 million of its receivables to these purchasers in the future andtherefore would have access to cash proceeds from these sales. The amount ofthe eligible receivables varies during the year based on seasonality of thebusiness. For example, the amount available could be less than $70 millionduring winter and spring. During the quarter ended March 31, 2008, no receivableswere sold to third parties under this arrangement. There is presently only one purchaser that is requiredto purchase receivables under the arrangement. If this purchaser were to exercise its right to terminate itsparticipation in the arrangement, which it may do in the third quarter of eachyear, the amount of cash available to the Company may be reduced or eliminated.

 

TheCompany maintains lease facilities with banks totaling $68 million, whichprovide for the financing of branch properties to be leased by the Company. At March 31,2008, approximately $68 million was funded under these facilities.Approximately $15 million of these leases are treated as capital leases andhave been included on the balance sheet as assets with related debt as of March 31,2008. The balance of the funded amount is treated as operating leases. TheCompany has guaranteed the residual value of the properties under the leases upto 73 percent of the fair market value at the commencement of the lease.At March 31, 2008, the Company’s residual value guarantee related to theleased assets totaled $53 million for which the Company has recorded theestimated fair value of this guarantee (approximately $0.1 million) in theConsolidated Statements of Financial Position. In connection with the closingof the Merger, the Company amended these leases effective July 24, 2007.Among the modifications, the Company extended the lease terms through July 24,2010. The operating lease and capital lease classifications of these leases didnot change as a result of the modifications.

 

Themajority of the Company’s vehicle fleet and some equipment are leased throughoperating leases. The lease terms are non-cancelable for the first twelve-monthterm, and then are month-to-month, cancelable at the Company’s option. Thereare residual value guarantees by the Company (ranging from 70 percent to87 percent of the estimated terminal value at the inception of the leasedepending on the agreement) relative to these vehicles and equipment, which historicallyhave not resulted in significant net payments to the lessors. At March 31,2008, there was approximately $174 million of residual value relating tothe Company’s fleet and equipment leases. Approximately $58 million of thisresidual value is with a lessor that has exercised its option to terminate thelease effective August 2008. The cost of acquiring the assets subject tothese leases is expected to amount to approximately $50 million. The fairvalue of the assets under all of the fleet and equipment leases is expected tosubstantially mitigate the Company’s guarantee obligations under theagreements. At March 31, 2008, the Company has recorded the estimated fairvalue of this guarantee of approximately $2 million in the ConsolidatedStatements of Financial Position.

 

TheCompany’s ongoing liquidity needs are expected to be funded by net cashprovided by operating activities and, as required, borrowings under theRevolving Credit Facility. We expect that cash provided from operations andavailable borrowings under the Revolving Credit Facility will providesufficient funds to operate our business, make expected capital expendituresand meet our foreseeable liquidity requirements, including payment of interestand principal on our debt. As of March 31, 2008, the Company had $455million of remaining capacity available under the Revolving Credit Facility.

 

Asa holding company, we depend on our subsidiaries to distribute funds to us sothat we may pay our obligations and expenses, including our debt serviceobligations. The ability of our subsidiaries to make distributions anddividends to us depends on their operating results, cash requirements andfinancial condition and general business conditions. As previously described,certain of our subsidiaries are subject to legal and regulatory restrictions onthe payment of dividends to us.

 

TheCompany’s 2007 Annual Report on Form 10-K included disclosure of theCompany’s contractual obligations and commitments as of December 31,2007.  The Company continues to make thecontractually required payments and therefore, the 2008 obligations andcommitments as listed in the 

 

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December 31,2007 Annual Report on Form 10-K have been reduced by the required payments.  There were no material changes outside ofordinary course of business in the Company’s previously disclosed contractualobligations and commitments during the three months ended March 31, 2008.

 

***Financial Position—Continuing Operations***

 

Receivablesdecreased from year-end levels, reflecting increased accounts receivablecollections offset in part by accounts receivable growth as a result ofincreased seasonal activity.

 

Inventoriesincreased from year-end levels, reflecting increased seasonal activity.  Prepaid expenses and other assets increasedfrom year-end primarily reflecting preseason advertising costs at TruGreenLawnCare as well as costs of annual repair and maintenance procedures that areperformed primarily in the first quarter at TruGreen LawnCare. These costs aredeferred and recognized over the production season and are not deferred beyondthe calendar year end. Deferred customer acquisition costs increased,reflecting the seasonality in the lawn care operations. In the winter andspring, this business sells a series of lawn applications to customers, whichare rendered primarily in March through October. These direct andincremental selling expenses which relate to successful sales are deferred andrecognized over the production season and are not deferred beyond the calendaryear-end. The Company capitalizes sales commissions and other direct contractacquisition costs relating to termite baiting and pest contracts, as well ashome warranty agreements. These costs vary with and are directly related to anew sale, and are amortized over the life of the related contract.

 

Propertyand equipment was consistent with year-end levels.  As further discussed in “Liquidity”, theCompany expects to pay approximately $50 million to acquire assets in connectionwith exiting certain of its fleet leases. The Company has no additionalmaterial capital commitments at this time.

 

Deferredrevenue increased from year-end levels, reflecting the significant amount ofcustomer prepayments recorded in the first quarter (pre-season) at TruGreenLawnCare.

 

Accruedpayroll and related expenses include provisions for payments due under changein control and severance agreements and provisions for litigation reserves.Accrued payroll and related expenses have decreased from year end levels,reflecting the payment during the first quarter of incentive compensationrelated to 2007 performance and the payment during the first quarter ofpayments due under change in control and severance agreements.

 

Totalshareholder’s equity was $1,215 million at March 31, 2008 as compared to$1,304 million at December 31, 2007.

 

***Financial Position—Discontinued Operations***

 

Theassets and liabilities related to businesses held pending sale and discontinuedbusinesses have been classified in a separate caption on the ConsolidatedStatements of Financial Position. Assets from the businesses held pending salehave decreased reflecting decreases in receivables at the InStar business.

 

Aspart of the American Residential Services and American Mechanical Services saleagreements, the Company guaranteed obligations to third parties with respect tobonds (primarily performance and license type), operating leases for which theCompany has been released as being the primary obligor, real estate leased andoperated by the buyers, and other guarantees of payment. At the present time,the Company does not believe it is probable that the buyers will default ontheir obligations subject to guarantee. The fair value of the Company’sobligations related to these guarantees is not significant and no liability hasbeen recorded.

 

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**Information Regarding Forward-Looking Statements**

 

Thisreport includes forward-looking statements and cautionary statements. Some ofthe forward-looking statements can be identified by the use of forward-lookingterms such as “believes,” “expects,” “may,” “will,” “should,” “would,” “could,”“seek,” “intends,” “plans,” “estimates,” “anticipates” or other comparableterms. These forward-looking statements include all matters that are nothistorical facts. They appear in a number of places throughout this report andinclude, without limitation, statements regarding our intentions, beliefs orcurrent expectations concerning, among other things, our results of operations,financial condition, liquidity, prospects, growth strategies, the industries inwhich we operate, customer retention, employee retention, communicationsimprovements, the continuation of tuck-in acquisitions, our ability to makecash interest payments on our debt, restructurings and reorganizations,including Fast Forward, and cost savings from such restructurings andreorganizations, and any expected charges or savings.

 

Forward-lookingstatements are subject to known and unknown risks and uncertainties, many ofwhich may be beyond our control. We caution you that forward-looking statementsare not guarantees of future performance or outcomes and that actual outcomesand performances, including, without limitation, our actual results ofoperations, financial condition and liquidity, and the development of theindustries in which we operate may differ materially from those made in orsuggested by the forward-looking statements contained in this report. Inaddition, even if our results of operations, financial condition and liquidity,and the development of the industries in which we operate are consistent withthe forward-looking statements contained in this report, those results ordevelopments may not be indicative of results or developments in subsequentperiods. A number of important factors, including the risks and uncertaintiesdiscussed in Item 1A—Risk Factors in our Annual Report on Form 10-Kfor the year ended December 31, 2007, could cause actual results andoutcomes to differ materially from those in the forward-looking statements.Factors that could cause actual results and outcomes to differ from thosereflected in forward-looking statements include, without limitation:

 

·                  the effects ofour substantial indebtedness and the limitations contained in the agreementsgoverning such indebtedness;

 

·                  our ability togenerate the significant amount of cash needed to service our debt obligations;

 

·                  increases ininterest rates;

 

·                  weatherconditions and seasonality factors that affect the demand for our services;

 

·                  changes in thesource and intensity of competition in our markets;

 

·                  higher fuelprices or lack of fuel availability;

 

·                  increases inoperating costs, such as higher insurance premiums, self-insurance costs andhealth care;

 

·                  employeeretention, labor shortages or increases in compensation and benefits;

 

·                  the risk thatthe benefits from the Merger or Fast Forward may not be fully realized or maytake longer to realize than expected;

 

·                  changes ingeneral economic conditions in the United States, especially as they may affecthome resales, consumer confidence or spending levels including as a result ofinflation, interest rate fluctuations, mortgage foreclosures or subprime creditdislocations;

 

·                changes in the type or mix of our serviceofferings or products;

 

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·                governmental regulation and the enforcementthereof, including telemarketing, potential direct mail or other marketingrestrictions, the Termite Inspection Protection Plan and legal restrictions orbans on pesticides and fertilizers;

 

·                the success of our current restructuringinitiatives, including the implementation of Centers of Excellence;

 

·                the number, type, outcomes and costs of legalor administrative proceedings;

 

·                possible labor organizing activities at theCompany or its franchisees;

 

·                risks inherent in acquisitions;

 

·                the timing and structuring of our businessprocess outsourcing and risks associated with such outsourcing; and

 

·                other factors described from time to time indocuments that we file with the Securities and Exchange Commission.

 

Youshould read this report completely and with the understanding that actualfuture results may be materially different from expectations. Allforward-looking statements made in this report are qualified by thesecautionary statements. These forward-looking statements are made only as of thedate of this report, and we do not undertake any obligation, other than as maybe required by law, to update or revise any forward-looking statements toreflect changes in assumptions, the occurrence of events, unanticipated orotherwise, changes in future operating results over time or otherwise.

 

**Comparisons of results for current and any priorperiods are not intended to express any future trends, or indications offuture, performance, unless expressed as such, and should only be viewed ashistorical data.**

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The Company is exposed to the impact of interest rate changesand manages this exposure through the use of variable-rate and fixed-rate debtand by utilizing interest rate swaps. The Company does not enter into contractsfor trading or speculative purposes. The market risk associated with debtobligations and other significant instruments as of March 31, 2008 has notmaterially changed from December 31, 2007 (see Item 7A of our AnnualReport on Form 10-K for the year ended December 31, 2007) except asnoted below.

 

InFebruary 2008, the Company entered into two 3-year interest rate swapagreements and one 4-year interest rate swap agreement, effective March 3,2008. The total notional amount of the 3-year agreements was $250 millionand the total notional amount of the 4-year swap agreement was $250 million.Under the terms of the agreements, the Company will pay a weighted averagefixed rate of interest of approximately 3.15% on the $250 million notionalamount of 3-year swap agreements and 3.48% on the 4-year swap agreement. TheCompany will receive a floating rate of interest (based on three month LIBOR)on the notional amount. Therefore, the effective interest rate for$500 million of the term loans is fixed at a rate between 5.90% and 6.23%,including the borrowing margin described in Note 14 to the consolidatedfinancial statements in the 2007 Annual Report. In accordance with SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities”, these interestrate swap agreements are classified as cash flow hedges and, as such, thehedging instruments are recorded on the balance sheet as either an asset orliability at fair value, with the effective portion of the changes in fairvalue attributable to the hedged risks recorded in other comprehensive income.

 

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Thefollowing table summarizes information about the Company’s debt as of March 31,2008 (after considering the effect of the interest rate swap agreements),including the principal cash payments and related weighted-average interestrates by expected maturity dates.

 
| ** **                                   | ** ** | **Expected Year of Maturity** | ** ** | **Fair** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|----------|------------|
| **As of March 31, 2008** | ** ** | **2008**                                     | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **Value** | ** ** |
| ** **                                   | ** ** | **($ in millions)**                | ** ** |
| **Debt:**                                    |       |                                         |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate                                   |       | $                                            | 12         |     | $          | 17 |   | $ | 13 |   | $ | 7 |   | $ | 3 |   | $ | 1,390 |   | $ | 1,442 |   | $ | 1,313 |   |
| Average interest  rate                       |       | 5.4                                          | %          | 5.6      | %          | 6.1 | % | 6.2 | % | 6.9 | % | 7.1 | % | 7.0 | % |   |   |
| Variable rate                                |       | $                                            | 65         |     | $          | 27 |   | $ | 41 |   | $ | 27 |   | $ | 27 |   | $ | 2,623 |   | $ | 2,810 |   | $ | 2,147 |   |
| Average interest  rate                       |       | 5.5                                          | %          | 5.5      | %          | 5.5 | % | 5.5 | % | 5.5 | % | 7.8 | % | 7.6 | % |   |   |
|                                         |       |                                         |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest  Rate Swaps:**                    |       |                                         |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Receive  variable/pay fixed                  |       |                                         |       |     |       | $ | 530 |   | $ | 250 |   | $ | 250 |   |   |   |   |   |   |   |
| Average pay rate                             |       |                                         |       |     |       | 5.1 | % | 3.2 | % | 3.5 | % |   |   |   |   |   |   |
| Average receive  rate                        |       |                                         |       |     |       | 2.7 | % | 2.7 | % | 2.7 | % |   |   |   |   |   |   |

 

##### **ITEM4T. CONTROLS AND PROCEDURES**

##### ** **

**Effectivenessof Disclosure Controls and Procedures.**  ServiceMaster’sChief Executive Officer, J. Patrick Spainhour, and ServiceMaster’s Senior VicePresident and Chief Financial Officer, Steven J. Martin, have evaluatedServiceMaster’s disclosure controls and procedures (as defined in Rule 15d-15(e))as of the end of the period covered by this Quarterly Report on Form 10-Q.  ServiceMaster’s disclosure controls andprocedures include a roll-up of financial and non-financial reporting that isconsolidated in the principal executive office of ServiceMaster in Memphis,Tennessee. Messrs. Spainhour and Martin have concluded that both thedesign and operation of ServiceMaster’s disclosure controls and procedures areeffective.

 

**Changesin Internal Control over Financial Reporting.**  No change inServiceMaster’s internal control over financial reporting occurred during thefirst quarter of 2008 that has materially affected, or is reasonably likely tomaterially affect, ServiceMaster’s internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1A: RISK FACTORS**

 

There have been no materialchanges from the risk factors previously disclosed in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2007.

 

**ITEM 6: EXHIBITS**

** **
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                     |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                     |
| 31.1                 |       | Certification of Chief  Executive Officer Pursuant to Rule 15d – 14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                             |
|                 |       |                                                                                                                                                                                                     |
| 31.2                 |       | Certification of Chief  Financial Officer Pursuant to Rule 15d – 14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                             |
|                 |       |                                                                                                                                                                                                     |
| 32.1                 |       | Certification of Chief  Executive Officer Pursuant to Section 1350 of Chapter 63 of Title 18 of  the United States Code, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|                 |       |                                                                                                                                                                                                     |
| 32.2                 |       | Certification of Chief  Financial Officer Pursuant to Section 1350 of Chapter 63 of Title 18 of  the United States Code, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURE**

 

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

Date: May 14,2008
|   | THE  SERVICEMASTER COMPANY                         |
|--------|----------------------------------------------------|
|   | (Registrant)                                       |
|   |                                               |
|   | By:                                                | /s/  Steven J. Martin |
|   | Steven  J. Martin                                  |
|   | Senior  Vice President and Chief Financial Officer |

 

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